Categories: BankingLoans & Credit

MCLR : New Lending Rate on Bank Loans w.e.f Apr 2016 – Details, Components & Review

The Reserve Bank of India has issued new guidelines for setting lending rate (on loans) by commercial banks under the name Marginal Cost of Funds based Lending Rate (MCLR). It will replace the existing base rate system from April 2016 onwards.

Base rate system was introduced by RBI in July 2010 to ensure that banks can not lend below a certain benchmark. Also, to ensure that the changes in interest rate policy is effectively transmitted to the bank customers.

However, policy transmission could not become very effective as banks adopted various methods in calculating their cost of funds. At present, the banks are slightly slow to change their interest rate in accordance with Repo Rate change by the RBI.

You might have observed that RBI has cut interest rates to the tune of 125 basis points in this fiscal year. But, this has not been effectively transmitted to lending rates offered by the banks. Banks have so far lowered their base rate by only 50-60 basis points.

( A term called as  “Basis Points” is often used in monetary policy reviews. What is Basis Point? …. 1% is equivalent to 100 basis points)

Same is the case when interest rates are increased by the RBI. If RBI increases rates by say 100 basis points, banks increase their benchmark rates by say 50 basis points. So, the ‘base rate system’ has turned out to be not so effective method.

In this post let us understand – What is Marginal Cost of Lending Rate? Difference between MCLR and Base rate methods? How is MCLR calculated or determined? Is new MCLR system beneficial to borrowers & banks? What is the impact of MCLR on existing and new home loan buyers?

(You may like reading my post on – ‘What is CRR / SLR / Repo Rate / Reverse Repo Rate‘)

Latest update (06-Sep-2019) : RBI makes it mandatory for all Banks to link Loans to External Benchmark Rates. However, this is not applicable to NBFCs (like HDFC, LIC HFL etc.,). The existing borrowers will be given an option to port to new Lending rate. The interest rate under the loans linked to an external benchmark will be reset at least once in 3 months

How is MCLR calculated? (Components of MCLR calculation)

Let us first understand as to how banks make money or profit. The primary function of a bank is to lend money and to accept deposits from the public. The difference between advances and deposits is the income earned by the banks.

So, how is the base rate or Standard Lending Rate calculated by the banks? The main components of base rate system are;

  • Cost of funds (interest rates offered by banks on deposits)
  • Operating expenses to run the bank.
  • Minimum Rate of return ie margin or profit
  • Cost of maintaining CRR (Cash Reserve Ratio).

As you can see, the banks do not consider ‘repo rate’ in their calculations. They primarily depend on the composition of CASA (Current accounts & Savings Accounts) and deposits to calculate the lending rate. Most of the banks are currently following average cost of fund calculation. So, any cut or increase in rates (especially key rate like Repo Rate) by the RBI is not getting transmitted to the bank customers immediately.

(What is repo rate? – When we need money, we take loans from banks. And banks charge certain interest rate on these loans. This is called as cost of credit (the rate at which we borrow the money)

Similarly, when banks need money they approach RBI. The rate at which banks borrow money from the RBI by selling their surplus government securities to the central bank (RBI) is known as “Repo Rate.”)

As per the RBI’s new guidelines, it is mandatory for the banks to consider the repo rate while calculating MCLR with effective from 1st April, 2016. The new method — Marginal Cost of funds based Lending Rate (MCLR) will replace the present base rate system.

The main components of MCLR calculation are;

  • Operating Expenses
  • Cost of maintaining CRR
  • Marginal Cost of funds
    • After considering interest rates offered on savings / current / term deposit accounts.
    • Based on cost of borrowings i.e., short term borrowing rate which is repo rate & also on long-term borrowing rates.
    • Return on Net-worth
  • Tenor Premium (an additional slab of interest over the base rate, based on the loan tenure & commitments).

The main differences between the two calculations are i) marginal cost of funds & ii) tenor premium. The marginal cost of funds will have high weightage while calculating MCLR. So, any change in key rates (increase or decrease) like repo rate brings changes in marginal cost of funds and hence the MCLR should also be changed by the banks immediately.

(In economics sense, marginal means the additional or changed situation. While calculating the lending rate, banks have to consider the changed cost conditions or the marginal cost conditions.)

RBI’s key guidelines on MCLR

  • All loans sanctioned and credit limits renewed w.e.f April 1, 2016 will be priced based on the Marginal Cost of Funds based Lending Rate.
  • MCLR will be a tenor-based benchmark instead of a single rate. This allows banks to more efficiently price loans at different tenors based on different MCLRs, according to their funding composition and strategies.
  • Banks have to review and publish their MCLR of different maturities every month on a pre-announced date.
  • The final lending rates offered by the banks will be based on by adding the ‘spread’ to the MCLR rate.
  • Banks may specify interest reset dates on their floating rate loans. They will have the option to offer loans with reset dates linked either to the date of sanction of the loan/credit limits or to the date of review of MCLR.
  • The periodicity of reset can be one year or lower.
  • The MCLR prevailing on the day the loan is sanctioned will be applicable till the next reset date (irrespective of changes in the benchmark rates during the interim period). For example, if the bank has given you a one-year reset period in your loan agreement, and your base rate at the beginning of the year is say 10%, even if the interest rate comes to 9% in the middle of the year, you will continue at 10% till the reset date. Same will be the case even if the interest rate increases above 10%.
  • Existing borrowers with loans linked to Base Rate can continue with base rate system till repayment of loan (maturity). An option to switch to new MCLR system will also be provided to the existing borrowers.
  • Once a borrower of loan opts for MCLR, switching back to base rate system is not allowed.
  • Loans covered by government schemes, where banks have to charge interest rates as per the scheme are exempted from being linked to MCLR.
  • Like base rate, banks are not allowed to lend below MCLR, except for few categories like loans against deposits, loans to bank’s own employees.
  • Personal loans, auto loans etc., will not be linked to MCLR.
  • Fixed rate loans up to a tenor of 3 years will be brought under MCLR system.  Fixed rate with tenor of more than 3 years will be exempt from MCLR regime, meaning banks will have discretion in pricing the product.

How MCLR Works? (Example)

For instance, for salaried individuals, ICICI Bank has set a floating rate home loan at one-year MCLR of 9.20% with a spread of 25 bps for loans of up to Rs.5 crore. So, the interest rate will be 9.45% (9.20% +0.25%). This interest rate is valid till 30th April, 2016 (as given in the bank’s website). ICICI Bank has decided to set one-year MCLR as the benchmark rate for their home loans.

Though the MCLR is reviewed monthly, your home loan will be reset every year automatically, depending on the agreement with the bank.

So,  if you take a Rs.50-lakh home loan on 10th April,2016, your home loan interest rate would be 9.45% . You have to pay EMI installments at this rate of interest for the next 12 months.

Let’s say one-year MCLR gets revised to 9.% in April, 2017 and the spread remains the same then your home loan interest rate will be reset at 9.25% (MCLR of 9% plus spread of 25 bps).

How to Switch from Base Rate to MCLR?

This primarily involves two steps;

  • If you would like to switch to MCLR system then you have to request your banker to link your loan rate with MCLR instead of Base Rate.
  • Once your loan is linked with new MCLR rate, you can request your banker to reduce the quantum of ‘spread’. Your Banker may charge you one-time fee (conversion fee) for reduction in Spread. Henceforth, you will get the new Rate of Interest (ROI) which is linked with MCLR.

My Opinion 

  • If interest rate cycle is in a downward trend, MCLR can be beneficial to borrowers of loans like home loan buyers.
  • But do remember that the interest rates may not remain low forever, when the trend changes the MCLR rate hike can be swift.
  • If you are an existing home loan buyer and planning to repay your home loan in say next few years, you can consider switching to MCLR method (as of now the charges applicable to move to MCLR is not available, you have to account for these charges and then take final decision).
  • If you are planning to buy a property through a home loan, you may take the loan under existing base rate before 31st Mar, 2016. Based on the prevailing economic factors, the RBI may not cut interest rates in the very near future,  you may continue with base rate and anyways you have the option to move to MCLR at a later point of time, if RBI cuts rates.
  • It is too early to say if the change in base rate will actually be completely passed on to consumers. Because, do remember that banks still have the option to set a ‘spread‘ on loans. Banks are free to determine the range of spread for a given category of borrower or type of loan. (For example, if the loan interest rate offered to you is 10.25% and the new base rate as per MCLR is say 10%, 0.25% is the spread)
  • As far as banks are concerned, their margins might take a hit in the range of Rs 15,000 to Rs 22,000 crore assuming a 75 basis point decline (source – ICRA). Banks may lose when interest rates drop but will gain when rates increase. So, it all depends on how many instances of ‘rate cuts’ will happen in the future.
  • MCLR is applicable for Banks only. Hence this is irrelevant to home loans offered by NBFCs (Non-Banking Financial Companies) like LIC Housing Finance, Dewan Housing (DHFL), HDFC, Indiabulls etc.,

Latest News (07-Aug-2019) : RBI cuts Repo Rate by 35 basis points to 5.4% from 5.75%. This is the fourth consecutive rate cut from RBI , after a rate cut in February, April & June of 2019. The reverse repo rate has been revised to 5.15%.

Latest News (06-June-2018) : RBI hikes Repo Rate by 25 bps to 6.25%; 1st Repo Rate hike since January 2014. RBI has also increased the reverse repo rate to 6%.

Latest News (02-March-2018) : SBI Hikes Lending Rate for first Time Since April 2016. SBI has raised the one-year MCLR  rate to 8.15 % from current 7.95 %.

Latest update (02-Aug-2017) : RBI cuts Repo rate by 25 basis points. So, latest Repo rate is 6%. Reverse Repo rate has been cut by 0.25% to 5.75%. 

Latest MCLR Rate Cuts (02-Jan-2017) : State Bank of India (SBI) has made a deep 0.90% cut in its marginal cost of funds based lending rate (MCLR) across all maturities. Following this cut, home, auto, personal and other loans will become cheaper. With this cut, the one-year MCLR is at 8 per cent against 8.9 per cent. The new loans rates are effective from 1st January, 2017. 

Latest News (04-October-2016) : RBI cuts Repo Rate by 25 basis points to 6.25% and keeps CRR unchanged. ICICI Bank cuts its MCLR based lending rate by 5 basis points and the bank’s new one-year MCLR is at 9.05% with effective from 1st October, 2016.

Latest News (02-June-2016) : ICICI Bank has reduced its latest MCLR rate by 5 Basis points to 9.15% from 9.20% with effective from 1st June, 2016. 

Do you believe that this new base rate system will be  beneficial to loan borrowers? Kindly share your views on Marginal Cost of Funds based Lending Rate?

Continue reading :

  • RBI cuts Repo rate : Impact on your HOME LOAN

(Image courtesy of Stuart Miles at FreeDigitalPhotos.net)

This post was last modified on July 10, 2023 9:46 pm

Sreekanth Reddy

Sreekanth is the Man behind ReLakhs.com. He is an Independent Certified Financial Planner (CFP), engaged in blogging & property consultancy for the last 14 years through his firm ReLakhs Financial Services . He is not associated with any Financial product / service provider. The main aim of his blog is to "help investors take informed financial decisions." "Please note that the views given in this Blog/Comments Section/Forum are clarifications meant for reference and guidance of the readers to explore further on the topics/queries raised and take informed decisions. The information provided, therefore, should not be viewed as financial, legal, accounting, tax or investment advice."

View Comments

  • Hi Sreekanth,

    currently my SBI Home Loan is linked to MCLR and the Interest rate applicable to me is 9.35%, I am trying to get it reduced as current SBI Home Loan interest rates are 8.65% from January 2017. But not able to do so. SBI is not ready to reduce the rate as my HL is taken on Sep-2016.

    Can you explain me the process.

    • Dear Shirish,
      Kindly check your home loan Reset Period clause.
      Banks such as SBI and ICICI Bank Ltd have set one-year MCLR as the benchmark for home loans.
      Though the MCLR is reviewed monthly, your home loan will be reset every year automatically, depending on the agreement with the bank.

      • Hii Sir
        currently my SBI Home Loan is linked to MCLR and the Interest rate applicable to me is 9.35%, I am trying to get it reduced as current SBI Home Loan interest rates are 8.65% from January 2017. But not able to do so. SBI is not ready to reduce the rate as my HL is taken on Sep-2016 and my loan reset period is 1 year.
        Do i have any ways/option to get a benefit of 8.65% immediately (from feb onwards)

        • HI Sir,

          I have another doubt,person who is already in MCLR+spread, after 1 year mclr will be based on rate at that time, but what about spread? currently SBI has increased spread from 0.25 to 0.65 so next reset time , will spread also change for exiting costumer?

          • Dear Pavan,
            The Spread usually remains constant through the loan tenure.
            Kindly check the Terms & clauses in your home loan agreement.

  • Hi Sreekanth,

    Hope you are doing well!!

    I have a home loan in ICICI bank. It has been sanctioned on 13th May, 2016. I think the loan is linked with Base rate not MCLR method; since it is mentioned as FRR/PLR in the loan details. I opted for Fixed interest 9.40% for first 10 years in 12 years entire tenure. Could you please let me know what is FRR/PLR, Does it base rate or MCLR? I would like to switch the loan to MCLR. I'm not sure how to move forward; since the interest type is fixed. But, in the ICICI website it has mentioned that all the base rate customers can switch to MCLR without any charges. I don't know how the loan got sanctioned with base rate in May, 2016 whereas it should be MCLR. Please guide me on this. Does it possible to switch to MCLR? Thank you!!

    Regards,
    Ravi.

    • Dear Ravi,
      Kindly note that Fixed Rate home loans, personal loans, auto loans etc., will not be linked to MCLR.
      Did you take loan from ICICI bank or ICICI home finance?
      FRR / PLR - stands for Floating rate reference / Prime lending rate.

      "If your loan is from ICICI Home Finance Company Ltd, the new base rate will not be applicable. Your loan will continue to be on ICICI Home PLR (IHPLR). The base rate concept / norms are currently applicable to Banks only and not to housing finance companies."

      • Hi Sreekanth,

        I just got the confirmation email from ICICI. They told that my Home Loan is under MCLR method. Also, MCLR have both fixed an floating interest rate options. Does this information is correct? Please suggest!!

        In the meanwhile, I will check whether the loan is from ICICI bank or ICICI home finance.

        Regards,
        Ravi.

        • Dear Ravi,
          Even I have got an update;
          Fixed rate loans up to a tenor of 3 years are linked to MCLR. Whereas, Fixed rate with tenor of more than 3 years will be exempt from MCLR regime i.e. banks will have discretion in pricing the product.
          So, your banker might be right.

  • Hi sreekanth,

    I am having housing loan of 9L in SBI on floating interest rate (Base Rate) of 9.5%. and remaining tenure of payment is 100 months. Is it advisable to switch over to MCLR rate by paying switchover charges?

    • Dear Ram..You need to do the calculations and take decision.
      Reduction in interest payment & tax benefit Vs fee payable towards the switch.

  • Hi Sreekanth,

    I have opted for a Max Gain loan of Rs 43,15,550.00. I have parked Rs 8,70,600.00 in the Max Gain account as surplus fund which saves interest for me. Total loan tenure was 180 months. I have already paid 17 EMI's. So, i have 163 EMI's pending. Current interest rate is 9.25%. I have not prepaid the loan as i get same advantage by parking the money in Max Gain account i.e. save interest on the parked amount. My target is close the loan in another 5-6 years.

    So, what will be the interest rate charged for me if i convert it to MCLR with a female co-nominee? Does it sound a good idea to convert my loan to MCLR after you go through my details above? And, i have heard from few people that if a Max Gain account is converted to MCLR, then it looses the benefits of a Max Gain account, that putting extra money in loan account and withdrawing that whenever required. Is it true? Please give in your suggestions. Thanks!

    • Dear Tikon,
      I dont think the features of Max gain account will be withdrawn if one switches to MCLR system.
      For this switch, kindly note that SBI charges around 0.5 to 1% on outstanding loan amount as fee.
      So, try to do calculations and compare the fee Vs EMI saved (assuming new mclr rate + spread).
      You need to check with your banker about the applicable new rate to you.
      In case you have very aggressive plans to close the home loan in near future, switching can be ignored.

  • Dear Srikanth,
    Please tell me is the charge of 0.56% by SBI for switch over from the existing Base Rate to MCLR exempted/discounted for Defence personnel. I shall be grateful if an early reply is given.
    Thanks.

    • Dear Rajendra..I tried finding out if there is any such exempt, but could not find any such info on SBI portal.

  • Hi,
    I have currently have SBI max gain home loan with outstanding amount of 19 lakhs with another 13 years left at interest rate of 9.3%.
    Is it good to shift to new MCLR method and what are the expenses incurred in doing so.What will be may savings by converting to MCLR.

    Thanks in advance

    • Dear Shravan,
      You have to pay around 0.5% to 1% of your home loan oustanding amount as SWITCH fee, in case you do not have aggressive plan to Pre-pay your home loan, you may switch to MCLR in next financial year.

  • I have taken 43 lacs home loan from SBI in January 2014(loan section date 25th Jan 2014) for 25 yrs. My EMI is 39000 pet month.
    As per loan agreement the interest rate is (base rate + 0.15%) with monthly rests. In my home loan account it shows interest rate as 9.40%.
    When I will gate the benefit of current cut in interest rate by SBI? And how much it will be?
    Will it reflect after 25th Jan 2017?
    What if I switch to MCLR (before/after 25th Jan), how much it will be beneficial? Should I wait for 2-3 month and then switch to MCLR?

    Awaiting for your reply..! Thanks in advance.

    • Just adding more details:
      I have taken SBI-MAX GAIN Home Loan. How much interest rate will be applied to my loan?

      • Dear Raju,
        As your home loan is linked to base rate, the rate cut may or may not reflect in your loan rate, banker can take final call whether to adjust the rate or not.
        You may switch to new MCLR basis, may be in the beginning of next Financial year.

  • Continuation to my previous post,
    The SBI MCLR are 7.75 (One Month), 7.85 (Three Month), 7.90 (Six Month), 7.95 (One Year). If I want to switch I feel to opt for 7.85 (Three Month) having hope on future which may give more cuts. Another question here: Can I opt in future for year agreement also? Your inputs on this highly valuable

    • Dear Rama,
      You may consider switching to MCLR basis sometime in the beginning of next FY.
      Normally, if an individual has an aggressive Pre-payment plan (like yours), can stick to Base rate basis, but the lending rate cuts have been steep and as opined by you, we may see further cuts (may not be deep) in near future.
      The reset clause can mostly be one year with home loans (kindly check with your lender).

  • Hi! Sreekanth, Thank your for your efforts in making us aware and awake on all financial matters.
    I have a housing loan in SBI for 40 lacs @ 9.25% in base rate, loan taken in June 2015. As you know the present MCLR in SBI is 8.0% and we may see few more cuts in future. In this situation, how do you suggest me to whether switching is better option to MCLR? My loan will be continued for at least 5-7 years from now. If I switch to MCLR how much will I be benefitted and what is your suggestion on this considering the upfront charges @0.58 % on outstanding and spread etc.,
    Thank you in anticipation

  • I took 36 lacs home loan from SBI January 2016 for 15 yrs.my EMI is 39000 pet month.if I change to MCLR how much extra amount I have to pay.and what is. my EMI.is there any benefit for mr

    • Hi..SBI will charge SWITCH fee, kindly check with them about the % of fee (generally it can in the range of 05% to 1% of outstanding loan amount).

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Tags: base ratehousing loanLoansMarginal Cost of Funds based Lending RatemclrPrime lending rate
July 10, 2023

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