MCLR's full form is the Marginal Cost of Funds Based Lending Rate. It was introduced on 1st April 2016 to deal with issues arising from the previous regime of the base rate. The rate has been brought to assist borrowers in availing home loans and benefit from rate cut initiated by the Reserve Bank of India.
MCLR's meaning is the minimum interest rate below which a lending body or financial institution is not permitted to lend. Ever since the introduction of MCLR, every lending institution has to declare their overnight, 1-month, 2-month, 3-month, half-yearly, yearly and 2-year interest rates each and every month on a pre-announced date.
How is the Marginal Cost of Fund Based Lending Rate calculated?
It is essential to know what is MCLR, its function, working, and calculation to understand the effect of MCLR on loans.
The MCLR rate is calculated based on the following elements –
- Tenor premium - The risk attached to a loan is higher in the case of the lender when the tenor is longer. Thus, banks shift the burden of risk onto the borrowers by charging a premium on the loan.
- Operating cost - It includes expenses like the cost of fund-raising, excluding the costs covered by service charges.
- The marginal cost of funds - This includes components like the marginal cost of borrowing and returns on net worth.
- A negative balance in the CRR account - A negative carry on the CRR (Cash Reserve Ratio) account also affects the mandatory Statutory Liquidity Ratio a financial institution has to maintain.
MCLR is the advance version of the base rate system. It is a risk-based approach used to determine the ultimate lending rate. Any potential borrower should be clear about MCLR and its effect on loans before applying for one.
