MARGINAL COST OF FUNDS-BASED LENDING RATE (MCRL)

Marginal Cost of Funds based Lending Rate. It's a benchmark lending rate used by banks in India to set interest rates on loans, especially for new borrowers. The MCLR mechanism was introduced by the Reserve Bank of India (RBI) in 2010 to bring more transparency and responsiveness in the transmission of policy rates into lending rates by banks. The MCLR is closely linked to the actual deposit rates or the cost of funds of banks, making it a dynamic benchmark that reflects changes in the interest rate environment.

MCLR can be different for different loan tenures. For example, HDFC MCLR rates range from 8.25% - 9.20% for different tenures

What is the purpose of MCLR?

The primary purpose of MCLR (Marginal Cost of Funds based Lending Rate) is to enhance transparency and ensure a fair transmission of changes in the policy rates set by the central bank (like the Reserve Bank of India in the case of India) to the lending rates offered by commercial banks.

Here are its key purposes:

MCLR aims to make the process of determining lending rates more transparent by linking them directly to the bank's marginal cost of funds
MCLR helps in aligning the lending rates of banks with the prevailing market interest rates, which are influenced by the policy rates set by the central bank. This allows for quicker adjustments in loan rates in response to changes in the broader interest rate environment
It intends to ensure that changes in the cost of funds for banks are passed on to borrowers more equitably and promptly
MCLR allows banks to adjust their lending rates more frequently based on changes in their cost of funds, thereby promoting a more responsive lending rate structure
By ensuring a more responsive and dynamic lending rate structure, MCLR aims to encourage borrowing for investment purposes, thus potentially stimulating economic growth

How is MCLR calculated?

MCLR (Marginal Cost of Funds based Lending Rate) is calculated using the following components and methodology:

Marginal Cost of Funds (MCoF): It includes various factors such as the repo rate (the rate at which the central bank lends money to commercial banks), marginal cost of borrowings, return on net worth, and operating costs.
Tenor Premium: Banks add a premium to the MCoF based on the time period of the loan (tenor). Longer-term loans tend to have a higher tenor premium.
Negative Carry on Cash Reserve Ratio (CRR): Banks are required to maintain a certain portion of their deposits as reserves with the central bank (CRR). The cost of holding these reserves, known as the negative carry on CRR, might also be factored into the MCLR calculation.

The formula for calculating MCLR is:

$MCLR = MCoF + Marginal Cost of Funds x Interest Rate Reset Frequency + Tenor Premium + Operating Expenses + Negative Carry on CRR$

Banks are required to review and publish their MCLR rates monthly across various tenors (overnight, one month, three months, six months, one year, etc.) to which they lend. The rates are generally benchmarked against the repo rate or other short-term interest rates, ensuring that changes in these benchmark rates are swiftly transmitted to borrowers' loan rates.

Difference between Marginal Cost of Funds Based Lending Rate (MCRL)

Subject	Base Rate	MCLR (Marginal Cost of Funds based Lending Rate)
Calculation Method	Based on average cost of funds, administrative costs, profit margin, and other factors decided by the bank.	Based on marginal cost of funds, incorporating components like repo rate, cost of funds, operating expenses, etc.
Frequency of Revision	Typically revised by banks at their discretion.	Revised monthly as per the guidelines of the Reserve Bank of India (RBI) or the respective central bank.
Transmission of Policy Rates	Transmission may not be as prompt and responsive to changes in policy rates set by the central bank.	Offers more responsiveness to changes in the central bank's policy rates, aiming for quicker transmission.
Interest Rate Reset for Borrowers	Borrowers under the Base Rate regime may not see immediate changes in their loan rates even if the central bank changes policy rates.	Borrowers under MCLR see more immediate changes in their loan rates in response to changes in the central bank's policy rates.
Transparency	May lack transparency in determining lending rates.	Aims for greater transparency as it's linked to specific components like the repo rate, cost of funds, and operating expenses.
Loan Pricing	Might not reflect the current cost of funds for the bank, leading to potential discrepancies.	Tends to reflect the current cost of funds more accurately due to its calculation methodology.
Tenor-based Pricing	May have a uniform base rate for all loan tenors.	Incorporates a tenor premium, allowing for differential rates based on loan tenor.

MCQs On MCRL

1.What does MCLR stand for in the banking sector of India?

A) Marginal Cost of Financial Liability Ratio

B) Marginal Cost of Funds based Lending Rate

C) Minimum Credit Lending Rate

D) Marginal Credit Facilities and Loans Ratio

Answer: B) Marginal Cost of Funds based Lending Rate

2.What was the primary objective behind introducing the MCLR framework by the Reserve Bank of India (RBI)?

A) To fix uniform lending rates across all banks

B) To bring more transparency and responsiveness in the transmission of policy rates into lending rates by banks

C) To increase the profitability of banks

D) To reduce the frequency of changing lending rates

Answer: B) To bring more transparency and responsiveness in the transmission of policy rates into lending rates by banks

3.Which components are typically considered in the calculation of MCLR by banks in India?

A) Cost of administration and borrower's credit score

B) Repo rate and return on net worth

C) Inflation rate and loan repayment period

D) Marginal cost of funds, operating expenses, and tenor premium

Answer: D) Marginal cost of funds, operating expenses, and tenor premium

4.How frequently are banks required to review and publish their MCLR rates in India?

A) Quarterly

B) Annually

C) Monthly

D) Biannually

Answer: C) Monthly

5.Which of the following is true regarding the comparison between Base Rate and MCLR in India?

A) MCLR is determined by the Reserve Bank of India, while Base Rate is set by individual banks.

B) Base Rate is more transparent and responsive to policy rate changes than MCLR.

C) MCLR incorporates the marginal cost of funds, while Base Rate does not.

D) Base Rate and MCLR have the same calculation methodology.

Answer: C) MCLR incorporates the marginal cost of funds, while Base Rate does not

Previous Year Questions

1.What is/are the purpose/purposes of the 'Marginal Cost of Funds based Lending Rate (MCLR)' announced by RBI? (UPSC CSE 2016)

1. These guidelines help improve the transparency in the methodology followed by banks for determining the interest rates on advances.

2. These guidelines help ensure the availability of bank credit at interest rates which are fair to the borrowers as well as the banks.

Select the correct answer using the code given below:

A. 1 Only

B. 2 Only

C. Both 1 and 2

D. Neither 1 nor 2

Answer (C)

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MARGINAL COST OF FUNDS BASED LENDING RATE (MCRL)

MARGINAL COST OF FUNDS-BASED LENDING RATE (MCRL)

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