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?
Continue reading :
(Image courtesy of Stuart Miles at FreeDigitalPhotos.net)
This post was last modified on July 10, 2023 9:46 pm
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Currently, I have home loan from AXIS bank with Base rate + 0% spread.
Effectively my home loan rate is 9.5% as per Axis banks base rate.
As per previous Repo rate changes, banks generally reduce their base rate, which were automatically reducing my home loan rate.
do these MCLR changes going to change anything for me ?
do banks will reduce base rate in future ?
will my home loan will be reduced with any further reduction in repo rate ?
Dear Sushil,
Earlier, each bank used to calculate their base lending rate as per their own policies & procedures (off-course, as per the guidelines of RBI). Now, with the introduction of MCLR, we can see uniformity with regards to base rate calculation across banks/lending institutions.
The major differentiating factors among the banks loan products would be 'the quantum of spread' & 'reset clause'. Also, we can expect the rate changes (increase or decrease) to reflect in MCLR rates swiftly now.
Now, whether this new system is beneficial to the end customer or not, that we need to wait and see, as its too early to comment and analyze on this.
Dear Sir,
My current outstanding loan is Rs 3143968 and current ROI is 11.45 from LIC. I am looking to switch my loan from LIC to SBI with current ROI is 9.50 for Women. As you said there is further reduction of rate in coming month so should i wait for some more months and pay some conversion fees Rs 1150 to LIC to reduce loan interest to 10.20. please suggest.
Dear Dipak,
Before making the decision, you may try finding out if there are any foreclosure expenses /fees involved at LICHFL and also about the loan a/c opening charges/fees at SBI.
If you are eligible to get a home loan at SBI at 9.4%, suggest you to make a switch. But do remember that MCLR is applicable on fresh loans and not the base rate (old lending rate).
Even if the interest rates falls say after few quarters, your home loan interest rate will be decreased based on the 'reset' clause.
SBI has a floating rate system. You may switch immediately/ If the rates get lowered , you will get the benefit at that point of time automatically
Hi Sreekanth,
The spread on MCLR according to RBI is supposed to be based on the risk profile of each borrower. This means it must vary from a credit worthy borrower to a risky borrower. But all these banks have simply applied the current spread they have on the base rate to the MCLR on all customers.
Also another fact is the Operating expenses component on MCLR will be higher for govt banks like SBI while it must be lower for ICICI being private and efficiently managed.
But these banks have formed a cartel and the private banks wont lend any lower than govt banks, its always the SBI that announces MCLR first and then private banks follow.
Will a common man ever get fair deal from these banks? Whatever RBI does will not be enough to save the common man.
"risk profile of each borrower". How can you say if you are credit worthy borrower? If you lose your job, or die tomorrow which the banks and even you don't know, who will pay the loan? and so everyone is a risky borrower. And also if you and me are banks , you are bigger and I'm smaller and our interest rates are same I won't talk about any changes in interest rate as I want max profit. Both of us will be looking at each other wondering who would take the first step. And if you do it I will follow you. And I even don't know the perfect meaning of common man. We pay thousand s to eat in restaurants instead of doing it at home, and when it comes to paying EMI's we say we are common man and when will we get fair deal from these banks. We want 10% interest on our deposits and 4% int on loans
Dear Hemanth,
I partially disagree with you.
Yes, everyone is a risky borrower, but the quantum of risk that a bank or homeloan provider sees/underwrites can be different from one set of borrowers to the other set.
Not everyone can get a home loan offer from say SBI but everyone can get a home loan offer from say LICHFL. The risk varies and the underwriting policies/guidelines vary.
Dear Hemanth,
Firstly, I would like to remind you that home loans are "Secure" in nature, in that your home is the security to the banks for which they give you loans. So even if I die the day after taking the loan, the banks will recover their money after selling the home.
The logic you put making every one a risky borrower will mean banks should lend to nobody, so think about it.
Secondly, Credit worthiness is determined by the past behavior of a borrower for many years of his repayment behavior of credit cards, loans, etc, stable job and income for many years. Remember 2008 sub-prime crisis is brought on by US banks lending to non-credit worthy borrowers.
If you are only employed for 2 years, no bank will give you a loan. Hence credit worthy borrowers are so important to banks and they could get a better deal for what they are per se.
A common man here is someone who needs to avail a bank loan to purchase a home which isn't a luxury but a necessity.
Regarding deposit rates vs lending rates, in the last 12 months deposit rates have gone down from 8.75% to 7.25%. Lending rates have gone down from 10% base rate +0% spread (10%) to 9.20% MCLR + .25% spread (9.45%).
Now make your calculations if you can and find out what exactly the banks are doing regarding the two.
Have a nice day.
Dear Pradeep,
Agree with your views.
As mentioned in the article, "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."
Let's wait for some more time to know if MCLR is really beneficially to end customer or is this only a system change :)
Dear Sreekanth,
I'm reproducing the following from your Article:
"(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.”
I think , the borrwing money from banks by the public attracts interest known as "Lending Rates"(Base Rate / latest MCLR) Not as "Repo Rate''.
How, can be borrowing by Public from Banks and borrowing by Banks from RBI be the "Repo Rate"?
Kindly, clarify.
Dear Vinay,
The sentence "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)" is used just to explain the concept of 'borrowing' :)
Hi Sreekanth,
RBI has reduced the interest rates by 25bps.
I am planning to take a home loan from SBI in April or max May.
Currently the loans are offered at MCLR+25 (9.2+0.25) = 9.45
Also, this rate is valid only till April 31st.
Should I wait for May and apply or can i go ahead now, since the reset is 1 year in home loans from SBI is what I have heard.
Dear Raja..If you wait for some more quarters, you may see few more basis points reduction, so it all depends on your requirement.
But even if you opt for current MCLR, the new MCLR rate (if after reduction of interest rate) will be applicable to you after 12 months.
Thanks Sreekanth,
Nice Article. Just want to know if I switch from Base Rate to MCLR for my ICICI Home loan Spread will be the same?
Currently I have 0.15% spread.
Dear Brijesh..May or may not be, depends on your banker's guidelines.
I am planning to take the home loan from sbi please explain how this new MCLR is linking with home loan with some what example and which is best to choose of reset date like 3months or 6 months or 1 year
Dear krishna,
Very tough to say which is best to you. Kindly note that if you opt for say 3 months, your EMI may change frequently (3m, depending on the changed interest rates).
Hello Sreekanth,
I already own Home Loan with a ICICI bank and repaid almost 15 months and planning to go for a top-up home loan. I get good offers from India-bulls compared with ICICI. Which one to be preferred.? India bulls directly top up the loan with their current interest rate while ICICI keep little higher on the current rate for top-up.
Dear John..Kindly go through the other terms & conditions (fees, charges, penalties etc) besides the rate of interest and then take your decision.
Hi Sreekanth,
I am planning to take home Loan for purchase of a Plot in a developed layout. Which shall I opt, SBI or Indiabulls, both have tie-up with the developer. Heard that in SBI after 2 years the home loan will become mortgage loan and higher interest would be charged... Whereas in Indiabulls after 3 years home loan interest rate will be about 2% higher.. Any how I will not go for construction in near future. Kindly suggest and guide me. Also suggest Which would be better among Base rate or MCLR based interest calculation...
Dear Rambabu,
SBI Vs Indibulls?? To be frank its your choice based on your repaying capacity & the terms & conditions.
If I am getting/eligible for a loan from SBI then I prefer SBI to Indiabulls.
Base Rate Vs MCL - kindly go through the points provided in the article.
Hi Sreekanth,
I am planning to apply for Home Loan in March in SBI.
Please let me know, If I should go for it or ask my builder to wait for a month and go for it in April with the new MCLR rate.
Which one do you recommend. Also please let me know, how will it benefit me.
Thanks,
Deepak
Dear Deepak,
To start with I dont think it may not make a big difference to take home loan before april or in april 2016.
Somehow I sense that it is better to go for base rate plan and then switch to MCLR system as and when we have more information about this system.
But kindly note that your home loan banker may charge you for this switch.
Thansk Sreekanth for your reply.
Will try to get more info about MCLR stuff.
A couple of people who work in SBI has told me(ofcourse their assumptions) that MCLR will be atleast 30 to 50 points less than current base rate and so our home loan interest rate as compared to current rate.
Thanks,
Deepak
Dear Deepak..The chances of having a lower new base rate can't be ruled out too.
Hi,
SBI chairman has ruled out any further rate cuts this financial year. And I guess there is no need for them to reduce base rates after that as MCLR takes effect.
Also keeping base rates as is will encourage existing customers move to MCLR.
So the chances of base rates coming down looks slim as does RBI reducing repo rates in Feb.
Dear Pradeep,
We can't say there is 'no need' to reduce the base rate, because the difference of basis points between the RBI rate cuts & banks lending rate cuts is surely in the rage of 50 to 60 basis points.
So, even if RBI keeps the rates unchanged in Feb, banks can cut some basis points from April onwards. But one more point which is been expressed is that banks can adjust this difference by including it in 'spread'.
So, to start with it can be either way.