Marginal Cost Lending Rate (MCLR):

Effective 1st April RBI has asked Banks to move from the Base Rate Model to the Marginal Cost Lending Rate (MCLR) Model. All Banks till 31st March were giving loans at Base Rate + Spread (loading Factor). Base Rate was basically the average cost of the funds to the Banks. On this they had a small BPS spread on various categories of loans based on the risk analysis. Hence you would find that the spread on the Base Rates for Home Loans was very low it was higher for car loans & much higher for personal loans.

Please note that Base Rates were not determined by RBI. It was an internal Bank rate based on the average cost of the funds to the Bank. Hence you would find the Base rates were slightly different for different Banks. The flaw in the Base Rate model was that it was based on Average Cost of funds which was not easily possible to calculate & hence customers felt that al the rate cuts by RBI were not being passed on to their home loans.

It was correct in a sense wherein Banks have existing Fixed Deposits which have been locked in for long term at say 9.00% or 9.50%. These deposits will mature in 2-3 years from now & hence the Banks will have to continue to pay higher rates to them and do not have the option of foreclosing the deposits unlike what a customer has on a Home loan. Hence the average cost of funds was being reduced over a longer period after RBI reduction in CRR / Repo rates. This lead to lot of heart burns amongst the customers who felt that RBI has announced 3 rate cuts of 0.25% but my Bank has not done so. The dynamic RBI Governor Raghuram Rajan who has brought in many sweeping changes in the Banking system like No Pre Closure Pre Payment Charges, Base Rate over the old PLR model (you can read in detail about these on the Banking System pages of this website) took notice of this customer discomfort & introduced the MCLR.

In this model the Banks will not calculate their loan rates on the average cost of funds but on the Marginal Cost of funds. MCLR reflects the cost of funds for a particular tenure. Hence if a Bank cuts its 1 year deposit (FD) rate by 0.25% from 1st April its 1 year MCLR will go down by a similar rate. The buyers who are taking fresh loans after this date will get the benefit of this reduced rate. The MCLR will be reviewed every month and changes if any will be announced on the Bank’s websites. The flipside of this model is that existing customers even in the MCLR regime will continue to pay the old rates till the reset date (once a year) after which their loans will be automatically reset to the new MCLR.