MCLR Rate - Impact of MCLR on Home Loans

Marginal Cost of Funds Based Lending Rate, MCLR, is the minimum rate of lending, below which banks are not permitted to lend, except in cases that are allowed by the Reserve Bank of India (RBI). MCLR is an internal benchmark for banks and other financial institutions to determine the rates of interest on loans. It was introduced by RBI in the year 2016, replacing the existing Base Rate System which had been in place since the year 2010.

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MCLR Rate

What is MCLR?

MCLR is related to Repo Rate and Cost of borrowing incurred by banks. Previously, when RBI reduced the repo rate, banks would take a long time to pass on the benefits to the borrowers through lower lending rates. Now, banks are under the obligation to adjust their interest rates as soon as repo rate changes. As MCLR system has replaced the Base Rate system, renewal of credit limits and sanctioning of loans is done as per MCLR rates.

Goals of MCLR

The MCLR system was introduced keeping the following goals in mind:

• With interest rates and their calculations varying across the banking sector, MCLR aims to bring about transparency in the system.
• Allowing loans to be given out at rates which are acceptable to both lenders and borrowers.
• Transparency and better rates ensure the lenders are competitive, which increases their net worth in the long run.
• To better reflect the change in policy vis-a-vis lending rates charged by banks.

Impact of MCLR on Home Loans

MCLR is directly affected by the cost of borrowing of banks, like repo rate, Cash Reserve Ratio, Bank Rate and so on. Any change in repo rate will reflect in home loan floating interest rate. If RBI brings down the repo rate, it will reduce the MCLR, in turn reducing the floating rate of interest associated with home loans. This decline does not affect EMIs, rather, the loan tenure is reduced.

MCLR has an impact on floating rate home loans only and will have no effect if the home loan is taken at fixed interest rate. Loss or gain under the MCLR system is determined by the change in repo rate. When repo rate is lowered, it reduces interest rates and vice versa.

Difference between MCLR and Base Rate

• MCLR is dependent on Cash Reserve Ratio, Marginal Cost of Funds, Tenor Premium, and Operating Cost.

Base Rate depends on factors like profit, bank deposit rates, bank costs and so on.

• Repo Rate change is directly reflected in MCLR

Base Rate does not show effects of change in Repo Rate

• Lending rates based on MCLR are different across tenures.

Base Rate changes every quarter.

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How to Calculate MCLR?

The main elements of MCLR are as follows

• Tenor Premium

It is the premium charged by the banks for the risk associated with lending for higher tenors. Tenor is the amount of time left for repayment of the loan. Tenor premium is not specific to a loan class or borrower, but is uniform across all types of loans.

• Operating Cost

Banks incur various expenses for raising funds, opening branches, paying salaries and so on. All operating costs associated with providing loan products are included in operating costs. Cost of providing services which are recovered by way of service charges are not included.

• Marginal Cost of Funds

Marginal Cost of Funds Based Lending Rate (MCLR) is calculated by taking into account all the borrowings of a bank. Banks borrow funds from various sources, which include Fixed Deposits (FD), Savings accounts, Current accounts, equity (retained earnings), RBI loans and so on. The rates of interest on these borrowings is used for the calculation of Marginal Cost of Funds. The Reserve Bank of India has prescribed a formula for the calculation of MCLR, which is given below:

Marginal Cost of Funds = (Marginal Borrowing Cost × 92%) + (Return on Net Worth × 8%)

• Negative Carry on CRR

Banks are required to maintain cash with the Reserve Bank, called Cash Reserve Ratio (CRR), which doesn’t earn interest for the bank. Under MCLR, banks are given certain allowance for that, called Negative Carry on CRR, which is calculated as under:

Required CRR × [marginal cost ÷ (1 - CRR)]

How to Convert from Base Rate to MCLR?

Existing loans and credit limits linked to Base Rate will continue as such until renewal. If the existing borrower wishes to covert from Base Rate to MCLR, it can be done on terms agreed between the borrower and lender.

Let us take an example to understand the difference that a conversion to MCLR can have.

A loan of Rs 30,00,000 borrowed for a tenure of 25 years at an interest rate of 9.5%, will have an EMI of Rs 26,211 and total interest of Rs 48,63,270. After 9 years from the date of taking the loan, you will have paid Rs 24,13,186 as interest. If at this point, the loan is converted to MCLR for the remaining tenure of 16 years, at an average interest rate of 8.75%, the amount of interest for the remaining 16 years will be Rs 22,24,302. The total interest paid for 25 years (9 years Base Rate and 16 years MCLR) will be (24,13,186 + 22,24,302) Rs 46,37,488. Thus the total saving is Rs 2,25,782.

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