What is MCLR Rate? What is the Impact of MCLR Hike on Personal Loan Rates

MCLR, which stands for Marginal Cost of Funds based Lending Rate, is a benchmark rate set by banks to determine the interest rates on loans. This rate reflects the cost incurred by banks to fund their loan products and is crucial in determining the MCLR interest rate for borrowers.

The MCLR rate for personal loans is particularly significant for individuals seeking financial assistance in the form of personal loans. It directly impacts the cost of borrowing, as changes in the MCLR rate can lead to adjustments in the interest rates of personal loans. Understanding the MCLR rate today is essential for borrowers to make informed decisions about their loans.

What is MCLR Rate?

The MCLR rate is a critical component in the Indian banking sector, influencing the cost of borrowing for consumers. Introduced in April 2016, the MCLR replaced the previous base rate system to bring more transparency and responsiveness to lending rates. It represents the minimum interest rate that banks can charge on loans, including personal loans, and is a benchmark that reflects the bank’s own cost of acquiring funds.

Essentially, the MCLR is determined by the marginal cost of funds, operational costs, and a profit margin, ensuring that the rate is closely aligned with the current economic conditions. For borrowers, understanding MCLR in loan agreements is crucial. It directly affects the Equated Monthly Instalments (EMIs) they will pay.

MCLR rate for personal loans can vary from one bank to another and can change over time as the MCLR is revised. The revision of MCLR is typically done monthly, making it a more responsive and dynamic system compared to the previous base rate regime.

How to Calculate MCLR?

Components of MCLR

The calculation of the MCLR rate involves several key components. Firstly, the Marginal Cost of Funds (MCOF) is considered, which includes the cost of deposits and borrowings. Secondly, the Negative Carry on Cash Reserve Ratio (CRR) is factored in, representing the cost of maintaining a reserve with the RBI that earns no interest. Thirdly, banks include their Operating Costs, covering expenses like salaries and administrative costs. Lastly, a Tenor Premium is added, accounting for the risk associated with the loan duration.

Calculation Methodology

To calculate the MCLR, banks add the following components: MCOF, Negative Carry on CRR, Operating Costs, and Tenor Premium. The MCOF is determined based on the interest rates of deposits and borrowings. The Negative Carry on CRR is calculated using the CRR rate and the cost of funds. Operating Costs are derived from the bank’s actual expenses, and the Tenor Premium is based on the average maturity of the bank’s liabilities.

Review and Revision

Banks review and revise their MCLR rate periodically, typically monthly or sometimes quarterly. This revision reflects changes in funding costs and other economic factors. The dynamic nature of the MCLR rate today ensures that the MCLR interest rate for loans remains aligned with the current financial market conditions.

How does a MCLR-linked loan work?

A loan linked to the MCLR rate operates under a system that is more responsive to the current financial environment. In an MCLR-linked loan, the interest rate is determined based on the bank’s MCLR at the time of loan sanction and is subject to periodic revision.

• Reset Clause: The interest rate on a MCLR-linked loan is fixed based on the present MCLR rate at the time of loan sanction. This rate is subject to change at predetermined intervals, known as the reset period, which is usually annually. For example, if a loan is sanctioned at an MCLR of 8%, it maintain the same rate until the next reset date, irrespective of any changes in the MCLR in the interim.
• Spread: Along with the MCLR, banks add a spread to determine the final interest rate of the loan. This spread covers the bank’s risk and other costs. For instance, if the MCLR rate for personal loan is 9%, and the bank adds a spread of 0.25%, the effective interest rate becomes 9.25%.
• Impact on EMIs: Changes in the MCLR interest rate affect the Equated Monthly Installments (EMIs) of the loan. A hike in the MCLR leads to higher EMIs and vice versa. 
• Flexibility for Borrowers: Certain type of loans give borrowers the option to switch from the base rate to the MCLR system, which can be beneficial if the MCLR is lower. However, once switched, they cannot revert to the base rate system.

Impact of MCLR Hike on Personal Loan Rates

Regulation in Rate Changes

The introduction of the MCLR system marked a significant shift in how banks respond to changes in the Reserve Bank of India’s (RBI) rates. Previously, banks were quick to increase rates on floating-rate loans when the RBI hiked rates but slow to reduce them when rates were cut. The MCLR rate system aims to correct this by ensuring banks adjust their rates more promptly in line with changes in cost conditions.

Effect on Spread

Under the MCLR system, banks set a spread at the time of loan sanctioning, which can only be increased if there’s a change in the borrower’s credit profile. This system prevents banks from arbitrarily increasing the spread, which previously led to unjustified rises in interest rates for customers. Therefore, a hike in the MCLR rate will not necessarily translate into a disproportionate increase in the MCLR rate for personal loan, as the spread is regulated.

Transparency

The MCLR system enhances transparency in the pricing of floating-rate loans. With the MCLR in loan agreements being more closely tied to the current financial conditions and regulatory rates, borrowers have a clearer understanding of how their loan interest rates are determined and adjusted. This transparency helps borrowers anticipate and plan for potential changes in their loan repayments due to fluctuations in the MCLR rate.

Exemptions under MCLR

• The MCLR rate does not apply to fixed-rate loans. This includes fixed-rate home loans, car loans, and personal loans, where the interest rate remains constant throughout the loan tenure, irrespective of changes in the MCLR rate.
• Loans that fall under specific government schemes, where banks are directed to charge a certain rate of interest, are exempt from the MCLR framework. These schemes usually have their own predetermined interest rates, not influenced by the MCLR interest rate fluctuations.
• Loans taken from finance companies and housing finance companies do not fall under the MCLR system. The NBFCs have their own methods of determining interest rates, separate from the MCLR in loan system used by banks.
• Banks can lend below the MCLR rate for loans against deposits and for loans to their own employees. These are special categories where the standard MCLR rate for personal loan does not apply, allowing for more favourable terms for these specific groups.

Conclusion:

In the ever-evolving financial market, understanding the MCLR rate and its implications is crucial for any borrower. The MCLR, acting as a benchmark for setting loan interest rates, directly influences the MCLR interest rate for personal loans. However, it’s not just about the rates; it’s also about choosing the right financial partner.

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