What is MCLR?

Following the demonetisation drive by the Central government since November 8, banks have been awash with huge deposits. According to estimates, banks have collected cash deposits of over Rs 14.9 lakh crore since November 8. Besides, Prime Minister Narendra Modi announced that the banks would be reducing lending rates and announced credit sops for a few segments of borrowers.

Taking cue, on January 1, State Bank of India, the country’s largest lender, cut its marginal cost of funds-based lending rate (MCLR) across all tenors by 90 basis points (bps). A basis point is one-hundredth of a percentage point. The steepest cut in several years comes amidst nearly a decade low growth in home loan segment. The six-month SBI MCLR is now 7.95% and the three-year rate stands at 8.15%.

Before April 2016, under the base rate system – base rate is the minimum rate set by the RBI below which banks cannot extend loans banks used to change interest rates only occasionally when repo rates are considerably cut by the RBI. The banks take into consideration only the RBI’s LAF (Liquidity Adjustment Facility) for short term funds and would not change interest rates even if RBI modified the Repo rate the rate at which RBI lends to banks.

The verbal inducements by the RBI used to have little effect. But, since 2016 April, banks are made to implement MCLR to change their individual lending and deposit rates following changes in factors impacting the repo rate. The MCLR is decided by four factors such as operating costs, marginal cost of funds, negative carry on account of cash reserve ratio and tenor premium.

As such, banks have to calibrate their interest rates whenever there is change these factors. as per variation in their cost of funds. This is mandatory for loans of different tenure from overnight (one day) rates to one year. MCLR was introduced by RBI to ensure fair interest rates to borrowers as well as banks.

The MCLR succeeds in smooth transmission of benefits of rate cuts to consumes following repo rate changes or the other factors mentioned already. It is mandatory for banks to consider the repo rate while calculating their MCLR. MCLR also seeks to address the regulators primary objective of expediting monetary policy transmission along with augmenting uniformity and transparency in the calculation methodology of lending rates. MCLR rates are revised every month.