The full form of MCLR is Marginal Cost of Fund. The MCLR is the lowest rate of interest a bank can charge when making a loan. Because MCLR is an internal standard tied to tenor, the bank determines the rate based on how long a loan has to be repaid in full.
With effect from April 1st 2016, the RBI established the MCLR mechanism for determining advance interest rates. It took the role of the base rate system, which had been in effect since July 2010 and had been used to gauge lending rates for commercial banks. RNI implemented MCLR on April 1st, 2016, to evaluate loan interest rates.
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How is the MCLR determined?
Four components are used to calculate the MCLR, which is directly tied to the deposit rate itself.
- A premium tenor
The period of time a borrower would have to repay the loan is known as the tenor. The tenor premium will be the same for all loan types, indicating that it is not borrower-specific.
- The cost of funds at the margin
When one more rupee is raised by new finance, a corporate entity’s financial costs increase. This is known as the marginal cost of money. Based on the length of the loans, the MCLR is calculated.
- Operation expenses
It has to do with the cost of raising money in order to supply the loan product. However, it does not account for expenses that are incurred in addition to service charges.
- Due to the cash reserve ratio, there is a negative carry (CRR)
It occurs when the return on the CRR balance is zero. When the real return is less than the cost of the fund, it occurs. It will have an effect on the appropriate SLR (Statutory Liquidity Ratio) balance that each commercial bank is required to maintain.
Reasons for the Introduction of MCLR
Prior to the implementation of the MCLR scheme, the individual banks evaluated the base rate or minimum rate using a variety of criteria, with an emphasis on the marginal cost of funds, the average cost of funds, or the total cost of funds. The following is a list of the justifications for MCLR implementation.
- In order to raise bank lending rates
- Clarify how interest rates on bank advances are calculated.
- Making bank loans available at interest rates that are reasonable for lenders and banks
- To aid banks in being more effective, boosting their long-term profitability and contributing to economic growth.