The Reserve Bank of India introduced the MCLR process for calculating the rate of interest on 1st April 2016. It was put into effect in place of the base rate structure that was operational since 2010.
Under the present regime of MCLR rate, financial institutions have the option of offering all kinds of loans based on a floating or fixed rate of interest. Lending cannot be done at a rate less than the MCLR.
What is meant by MCLR?
MCLR full form is Marginal Cost of Funds Based Lending Rate. It is the lowest rate of interest that is offered by Housing Finance Companies and other institutional lenders when a borrower avails a loan.
It is essentially a reference rate or internal benchmark for all financial institutions offering some form of credit to their customers. It encompasses the process, which involves the determination of the minimum rate of interest on home loans.
How do MCLR and Base rate differ?
Financial institutions, prior to 1st April 2016, determined loan interest rates under the Base rate regime. It came into effect in 2010 but was replaced by RBI with MCLR, owing to several shortcomings that impacted borrowers adversely.
Therefore, in order to comprehensively understand MCLR and its effects on loan, it is crucial to glean what made it a suitable substitute for Base rate.
One of the primary distinctions between the base rate and MCLR rate is that the former accounted for fewer variables. For instance, in base rate calculation, financial institutions did not considered the interest rates on savings accounts.
Furthermore, the repo rate was not included during base rate computation either. This factor put borrowers at a disadvantage since they could not benefit from repo rate reductions. Essentially, the base rate failed to account for the marginal cost of funds and instead relied on an overall cost of funds.
The tenure premium is another aspect where these two regimes differ. In the case of a base rate, tenure premium was not included. In the calculation of MCLR, however, a financial institution is required to account for that to levy a fair rate from borrowers. It especially holds for home loan interest rates.
These are a couple of areas that prompted RBI to switch to Marginal Cost of Funds-based Lending Rate. It is essential to keep abreast of the MCLR rate when planning to avail long-term credit, like a home loan.
For instance, if you are planning for a home loan balance transfer, knowing the MCLR will allow you to better compare lenders. You can also look for better offers and terms of borrowing.
For example, leading financial institutions extend pre-approved offers to existing customers, which make the process of availing loan much simpler. Mostly, such offer includes various financial products, including home loans and loans against property. Check your pre-approved offer online by providing few basic details such as name and contact number.
MCLR in home loan
Lenders are obligated to provide an interest rate on home loan that is less than MCLR. However, some exceptions can be made on duly obtaining permission from the Reserve Bank of India.
MCLR is directly linked with the lender’s fund costs as well as the repo rate. With alteration in the repo rate, the floating rate of interest on home loans will also be impacted. If MCLR home loan rate is reduced by the lender, the floating interest rate will also be reduced. An aspect that needs to be known about MCLR based home loans is that with such changes, it is the tenure of loan that is affected but not the Equated Monthly Instalments.
Calculation of MCLR
In the calculation of the Marginal Cost of Lending Rate, the sources from where funds are borrowed by financial institutions have to be considered. Typical sources for lenders include current accounts, savings accounts, recurring and fixed deposits etc.
The rate of interest with respect to these borrowing sources can be referred for calculation of the marginal cost of borrowing. It should also be noted that these are not the only sources of funds for banks, which includes equity as well.
The formula of MCLR rate by the Reserve Bank of India is –
Marginal Cost of Funds Based Lending Rate = (Cost of Marginal Borrowing X 92%) + (net worth returns X 8%)
RBI guidelines indicate that it is mandatory for banks to maintain a minimum CRR (Cash Reserve ratio) of a at least 4%. It does not stand to earn any interest on such deposit. MCLR permits banks to obtain a specific amount known as ‘Negative Carry’ on CRR.
The operating cost will also have to be considered for the Marginal Cost of Lending Rate. A financial institution runs several expenditures, which is inclusive of the fund costs, employee salaries, and establishment expenses. This expenditure is not to be billed to its customers.