What is the full form of MCLR
MCLR: Marginal Cost of Funds based Lending Rate
MCLR stands for Marginal Cost of Funds based Lending Rate. It is the minimum lending rate below which a bank is not allowed to lend, except in some cases.
It is the method by which the minimum interest rate for loans is determined by a bank based on the marginal cost. The MCLR method for fixing interest rates for advances was introduced by the Reserve Bank of India with effect from 1 April 2016. It has replaced the old method of base rate system, which was introduced in July 2010 to determine the lending rates for commercial banks. It was implemented on 1 April 2016 by RNI to determine rates of interest for loans.
MCLR is based on four components: the marginal cost of funds, tenor premium, operating expenses, and Cash Reserve Ratio (CRR).
- Tenor premium: Tenor is the amount of time a borrower has to repay the loan. The tenor premium is the same for all types of loans, i.e., it is not borrower-specific.
- The marginal cost of funds: The marginal cost of funds refers to the increase in financial costs for a business entity when one more rupee is increased of new funding. MCLR is calculated on the basis of loan tenor.
- Operating cost: It is linked with providing the loan product, which includes the cost of raising funds, but does not take into account the costs which are separately recovered through service charges.
- Negative Carry on account of CRR (Cash Reserve Ratio): It takes place when the return on the CRR balance is zero. It occurs when the actual return is less than the cost of the funds. It will affect the required Statutory Liquidity Ratio (SLR) Balance that every commercial bank is required to maintain.
Prior to the MCLR system, the different banks were using different methodologies for calculation of base-rate/minimum rate such as based on the average cost of funds or marginal cost of funds or blended cost of funds.
Reasons for Introducing MCLR:
- To improve the lending rates of banks
- To bring transparency in determining interest rates on advances by banks
- To make bank credit available at interest rates which are fair to borrowers and banks
- To assist banks in becoming more competitive and improve their long-run value and contribution to economic growth