What Is MCLR And How It Affects You?

From benchmark prime lending rates (BPLR) to base rate and now marginal cost of fund-based lending rates (MCLR), the banking sector has undergone various changes to its rate-setting methodologies. The Reserve Bank of India (RBI) recently said that MCLR will replace the existing base rate system as the new method for deciding the commercial banks' lending rates, from April 2016.
Any change in interest rate, however small, can affect our buying power immensely. PropGuide, therefore, explains how the change in benchmarking will affect you.

The new benchmark

MCLR is the new benchmark lending rate at which the borrowers will be given loan from now on. It is built on four major components:

Marginal cost of funds (MCF): It is the incremental cost of funding an additional loan, assuming that the bank's average cost of funds remains the same. For banks, it is the marginal cost of borrowing and return on its net worth.

Negative carry on account of cash reserve ratio: CRR is the proportion of total deposits that banks have to park with RBI in cash and other liquid assets. The cost of such funds kept idle can be charged from loans given to people.

Tenure premium: It is the amount that increases with the loan period.

Operating cost: The cost of providing loan products, including the cost of raising funds. It includes the cost of operating a banking business.

The RBI asked commercial banks to set either monthly or yearly MCLR rates. This means you will have new interest rates on your home loan at a pre-decided time. Banks are also allowed to determine their spread higher than MCLR, depending on the credit risk and tenure of a loan.

The concept

Marginal means 'additional'. While calculating the lending rates, banks have to consider the additional or changed cost conditions, which will affect the MCLR at which a loan will be given.

So, if you plan to take a home loan at a floating rate, it will now be linked to MCLR. It is advisable to go through the reset clause at the pre-specified interval of the floating home-loan rate agreement. This means if the bank has set a six-month frequency for home-loan interest rate, the rate will be reset every six months, in case of a change in MCLR.

Impact on monetary policy

The major impact that MCLR has on the monetary policy is that the banks will have to consider the changes in the repo rate while calculating MCLR. Earlier, under the base rate regime, the repo rate cuts were considered occasionally because there was no pre-specified interval clause. Now, with MCLR, banks will have to readjust the rate of interest monthly or yearly, depending on this clause. So, the revision of MCLR at different intervals will take into account the repo rate movement.

The many traits

The loan rates will be competitive with MCLR which will help the borrowers reap the benefit of lower charges. There will also be an improvement and transparency in the methodologies followed by banks in determining their loan rates. The MCLR is the fair lending rate for both borrowers and lenders.
Borrowers might, on the flip side, find the changes in MCLR at different reset dates a little confusing and complicated. The frequent changes in the rate could also affect their planned budget.