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
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;
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;
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.)
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).
This primarily involves two steps;
My Opinion
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?
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(Image courtesy of Stuart Miles at FreeDigitalPhotos.net)
This post was last modified on July 10, 2023 9:46 pm
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Dear Sir
I Am New To this & Planning To take Home Loan for 25 lakh for the tenure of 15 years in the name of me & My Wife in this month itself...So Let me Know how to move is it with MCLR OR BASE rate...& which is advantage
Thanks
Dear Vijay,
Kindly note that all loans sanctioned and credit limits renewed w.e.f April 1, 2016 will be priced based on the MCLR only.
sir after april 2016 all loans sanctioned are only mclr based no option to choose base rate.
Dear Sir
I have taken home loan from SBI on floating interest rate 10.15% in April 2015 (on 15 bps above BR 10%). Till Oct 2015 our home loan interest rate decrease as BASE RATE decrease by SBI and it reduced to 9.45% (on 15 bps above BR 9.30%) but since Oct 2015 SBI charging same interest rate till now. As per RBI guidelines SBI now providing loan on MCLR basis (current rate of interest is 25 bps above 1 year MCLR, ER 9.15%p.a.).
As my loan is on floating interest rate and since April 2016 many times RBI reduced its REPO rate but SBI not providing that benefit to me or say existing home loan account holders.
Kindly suggest what I should do in such a case whether we can do some thing?
You are also requested to suggest me whether it is beneficial that we shift to MCLR basis loan (SBI is charging 0.50 % + applicable Service Tax of the outstanding for switch over) My loan was approved for 19 Years and I have done some prepayment also without any charges.
Dear Praveen,
Yes, you can surely negotiate with your banker about the possibility of rate reduction on your home loan.
Kindly note that, banks has the liberty to charge extra spread even if it is MCLR system. The only thing is this new system can be a more efficient and transparent one. Also, the banker may charge 'SWITCH' fees.
Really loved your blog Sreekanth. You really have made me understand the idea of MCLR in best possible, simple and lucid language.
Thank you dear Nirmal ..Keep visiting and do share the articles with your friends :)
I have taken SBI Home Loan during November 2015 (one year back) with 9.55% Floating Interest Rate (RBI Base Rate 9.30% + Spread Rate 0.25%). During this one year, SBI has reduced the interest rates thrice i.e. 9.40%, 9.30% and now 9.15%. However, my interest rate remains the same. Contacted SBI several times, but they are not giving any clear reply and simply confusing me stating Base Rate, MCLR, Spread Points, etc. and finally telling for switch over of interest rate a processing fee of 0.58% of my Outstanding amount is to be paid.
They are also telling that for newly sanctioned Home Loans the interest rate is RBI MCLR rate plus Spread rate of 0.40% with one year reset (MCLR-8.90% + Spread rate-0.40% = 9.30%) where MCLR is floating and Spread rate is constant.
Please clarify me on this issue, as SBI is telling that there is no change in Base Rate for my account as of now and if there is any change (increase of decrease) in this, they will change accordingly.
Please help / clarify me on this, as how to proceed on this, as another 14 years tenure is remaining.
Dear Narendra,
Looks like your Loan account is linked to old Base rate system.
SBI wants to charge a processing fee of 0.58% , if you would like to switch from your old base rate system to new MCLR system.
You can negotiate with them for reducing the Spread (0.40%).
You may also check with other Lender if they can give you better rate of interest.
Thank you very much Sir.
"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?"
Well I see this is just another gimmick in futile attempt to control the lending rates of bank and complicate things for all. I still do no not see who the changes in rates from RBI will still trickle effectively to economy.
While now the MCLR should factor in the repo rate, but how much really the weightage is of this cost of borrowing from RBI for the bank as against rest of the marginal costs.
I do not have factual data, but assuming the points in the article above are facts, then we see that in base rate regime a reduction of 120 basis points resulted in 50-60 basis points reductions by banks. that's almost 50 % transmission.
while I see at the end of article below update:
"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."
So I don't see any more efficiency then in previous system with regards to transmission of RBIs rate changes.
In fact a majority of the section of loans will not see the transmission of RBI rates until their period of reset is completed. With most loans running into multi years, most will have reset of an year.
So the only impact it will have on are the ones who will get the new rates is the new loans. Is the new credit off take only things that effect the economy for RBI? doesn't the existing loans cost to the business who in turn pass on their consumer effect the economy?. doesn't the savings for existing home loan borrowers effect the spending? if existing loans have to wait for reset periods then RBIs motive of effective transmission is defeated.
For the consumer of least home loan borrowers, it will be a confusion and opens up probability for marketing guys to lay traps.
At least the older system of base rate where the rates changed less frequently (instead of monthly under MCLR) consumer could compare between banks and banks were forced to be competitive for this sake.
Now one month SBI will have lower MCLR due to its internal factors while the other month some other bank could have lower but just for that month to attract consumer and during month where in max reset occurs, bank will have tendency to jack up rate to lock in for another year. There is lot of opportunity of jugglery for banks and we might see those coming as system mature and banks understand how to play with it.
I don't see any real benefit to consumer. In fact consumer will depend upon his luck during the month his MCLR is going to reset and hope its lowest in the year. At least in base rate he was getting transferred the benefit (or paid more) along with rest of the existing borrowers.
In base rate regime it started with high spread and were almost wafer thing when removed. I would think with these thin spread the banks would have to really pass on the rates from RBI more quickly then in past though never instant.
If RBI really wanted instant effective transmission of its policy rates... then why not keep it simple
RBI rate + bank spread.
and let bank decide which ever formals for XYZ marginal cost or ABC profit targets to decide the spread.
if RBI rate changes then instantly its transferred to economy. And if it does not want 1:1 transmission then it can have something like
RBI rate * X + bank spread.
and specify x as efficiency at which it wants to transmit changes to economy.
and if you think its too much of controlling market then simply abolish it and let banks decide and be competitive. Anyways with frequent regime change from prime lending rate, base rates and now MCLR RBIs any ways is not able to control their rates.
Dear keyur,
Thank you for sharing your views in a very detailed way.
The main benefit that MCLR can bring is 'standardization' of rate structure across banks and more transparency in the lending rate system. Besides this, banks can still play with spread/margin so that the real benefits of rate cut (if any) may not be passed on to customers immediately or completely.
Keep visiting our blog :)
My Sbi home with base rate is 9.4%(9.3+0.1spread)
If I switch to mclr what will be my spread .???
What is the % to change to mclr.
MCLR Wont bring any change to the Spread . it just replace the earlier base rate ..Thats it
In your case SBI's MCLR is 9.20 at present , So your HL ROI will be ( 9.20+Spread )
If any one is looking to transfer your existing home loan to MCLR without any charges please let me now 9980007772
yes I am interested to switch my loan from base rate to MCLR, pls contact 9793888559
Dear Shrikanth,
I have a home loan of 27 lakhs with IDBI having base rate 9.75. When i visited the bank for prepayment they have told me about MCLR. They are offering MCLR 9.45 with the 0.1 fees. It is costing around 3500 RS approximately. Please suggest me should I go for MCLR or stay with base rate.
Dear Bhavesh ..It depends on the remaining tenure of your loan.
Hi Sreekanth,
What should the financial strategy of banks be in the new environment of MCLR?
Awaiting your response.
Thanks!
Dear Siddhanth ..On any given day, a bank's strategy would be to maximize the MARGINs :)
Hi Sreekanth,
Here is one strategy that bank follow to maximize their margins in the MCLR world. Not long ago in the era of base rates, banks hardly had any spread on the base rates. So basically most banks had base rates as their lending rates.
Now check the current rates, you will find every bank has a big fat spread on their lending rates. SBI has 0.25%, ICICI has 0.3% on their MCLR for Male borrowers.
It helps them in two ways,
1) The MCLR based rates are nearly equal to Base rates today, so they don't lose much by MCLR based lending
2) In a rising rate scenario, all those who availed loans in MCLR rates will continue paying the additional spread on top of the higher MCLR rates. This will ensure banks make a killing when interest rates are on their way up. Obviously MCLR will rise faster in a rising rate scenario.
Who said our bankers are weak and lazy? People like Mallya be better careful, My smart Indian bankers are coming after you.
Mr.Rajan, get outta here. You are finished.
Wow, good and valid inputs. Thank you for sharing your views dear Pradeep.
We need to note that Banks as with the case of any company are in for BUSINESS and not for charity.
Hi Sreekanth,
I totally agree with the you that Banks are for Business which is why I am against the policies of Mr Rajan. We should leave it to the market forces and banks themselves to determine what should be their lending and deposit rates. We all know that most of our banks are struggling with bad loans, so they are justified to keep their lending rates high and reduce deposit rates further to the tune that they continue to get deposits. A lot of our farmers and industrialists like Mallya are struggling to pay up their loans. I mean where will the banks get their capital from?
RBI should not intervene in these things. Rajan must take cue from Jaitley who is silent on this subject.
I am relieved that Rajan is out and hoping for a more tolerant RBI governor to take charge.
Absolutely poor assessment. You can not incentivise bad loans pushing capital which comes from taxpayers money. Banks are not there to create NPAs and seek Govt support for capital. They have to account for the bad loans and audit the reasons put forth by the defaulter and take action. NPA is out of proportion now. Rajan has taken the right stand which may not be palatable for the Industry,Trade & Commerce and the politicians. But truth remains truth.
Dear Sir,
Myself Anand I want few suggestions from you regarding CC or OD.
1) What should be minimum spread a bank can offer on MCLR or Base Rate for 1crore ?
2) What should be minimum processing fee a bank can offer for 1 crore ?
Please mention if RBI has any involvement in both of this...
Thank you...
Dear Anand ..The spread can vary from bank to bank.
Dear Sir,
If it vary bank to bank then what should be minimum according to you a bank can offer and processing fee...