The Reserve Bank of India
introduced MCLR or Marginal Cost of Funds based Lending Rate in 2016 to replace
the existing base rate system that was in operation since 2010. This shift
aimed to bring in more transparency in the process of interest rate determination
and to help borrowers reap the benefits of RBI’s policy rate change early
on.
This new system introduced a minimum lending rate threshold in place under which financial institutions were not allowed to lend. Gaining an understanding of the working principles of MCLR rates can help borrowers repay their credit affordably and improve their financial management.
What is MCLR?
The MCLR rates are the
minimum rate of interest at which financial institutions can offer loans and
advances to retail customers. Lenders use it as an internal benchmark to
determine the rate of interest on every credit option. Under this regime,
financial institutions are mandated to keep the minimum rates unto the threshold
of a pre-determined lending rate on various loan products.
Therefore, lenders cannot
favour any customer and offer a lower interest rate on a specific maturity.
They need to stick to the MCLR rate, which remains uniform for all credit
options linked to that benchmark. The reason to introduce MCLR is that the
lending system counts in the RBI’s policy rate changes, making it easier to
pass on the benefits of policy rate cuts to the customer.
With this understanding of
what is MCLR rate, take a look at its calculation as well.
How is MCLR calculated?
Since the MCLR
rate is a tenure-linked interest rate, it means financial institutions can
determine the rate of interest as per the repayment tenure of a loan. The
calculation of MCLR is based on four factors plus a percentage spread that a
financial institution adds to the benchmark rate. These are –
- Tenure
premium
It is an amount that lenders
charge to cover the risk associated with a loan as per the tenure availed.
However, tenure premium is not specific to a particular credit option. Instead,
it is uniform across all loan types and varies only with the tenure
differences.
- Marginal
Cost of Funds
Marginal Cost of Funds takes
into account the existing borrowings of a financial institution for MCLR
calculation. It includes credit availed from the RBI at a set repo rate. For
instance, the current repo rate considered for such calculation would be 4%. It
is primarily made up of two components, namely Return on Net Worth and Marginal
Cost of Borrowings. Here, the weightage on the Marginal Cost of Borrowings is
8% and on Return on Net Worth is 92%.
- Negative
carry on the Cash Reserve Ratio
Cash Reserve Ratio or CRR
represents the fund that a financial institution operating in India has to
mandatorily keep with the RBI towards ensuring security and liquidity. Any loan
extended is calculated negatively against the reserve in the books of a
financial institution as they cannot generate any income from it.
- Operating
cost
A lender incurs a series of
varying costs to ensure smooth running of its operations. It includes the
salary of the employees, interest on deposits, rent of branches, etc.
Calculation of MCLR rates considers these costs to arrive at the
final rate of interest to be charged on a particular financial product.
Benefits of MCLR rates over
the base rate system
The prominent benefits of MCLR
and its effects on
loans have been demystified below –
●
It brought
the much-needed transparency in the calculation of interest. In the base rate
regime, such transparency was an important issue shrouding the interest levy.
●
Under MCLR,
marginal cost of funds was considered instead of the total cost of funds. As a
result, it considers the repo rate in its calculation that base rate never did.
This results in better benefits to the borrowers.
●
Furthermore,
financial institutions revised this rate periodically, which helped borrowers
to avail better interest rate.
Nevertheless, with an introduction of RLLR or Repo Linked
Lending Rate as an external benchmarking system of lending replacing its
predecessor MCLR rates, the rates of interest on advances are set to gain
further transparency. This lending system has also been mandated in case
borrowers avail a home loan at a floating rate, thus ensuring increased
affordability for housing loan borrowers.
While applying for a home loan, borrowers should
thus check if their preferred lender is offering this facility or not.
Renowned lenders also provide
pre-approved offers to make loan processing hassle-free and time-saving. These
offers are available on several financial products, like home loans, loans
against property, etc. Borrowers can check their pre-approved offers by submitting
their essential details only.
Therefore, before applying for a home loan, borrowers should consider the best lending system to ensure easy repayment of their advances. Along with that, they must also take care of the important reasons why lenders may reject a home loan application and rectify them to improve their chances of approval.
