Login / Register
Lorem Ipsum is simply dumy text of the printing typesetting industry lorem ipsum.
C4S Courses Banner

Marginal Cost of Funds based Lending Rate

WhatsApp Channel
WhatsApp Channel
Edit Template
Telegram Channel
Telegram Channel
Edit Template
YouTube Channel
YouTube Channel
Edit Template
Marginal Cost of Funds based Lending Rate

Introduction

Interest rates are the heart of any lending system, and in India, the Reserve Bank of India (RBI) plays a critical role in regulating how banks lend to customers. Over the years, the RBI has introduced various benchmarks to improve transparency and ensure that the benefits of changes in repo rates are passed on to borrowers.

One such mechanism that brought transparency, efficiency, and market responsiveness into lending was the Marginal Cost of Funds based Lending Rate (MCLR), introduced in April 2016. This blog takes you on a comprehensive journey through the origin, structure, significance, comparison, and future of MCLR.

Historical Context

India’s lending landscape has evolved significantly over the past few decades:

Evolution of Lending Rate Systems in India

PeriodSystemKey Features
Pre-2003Benchmark Prime Lending Rate (BPLR)Lack of transparency, arbitrary pricing, favor to corporates
2003–2010Improved BPLRStill opaque, did not ensure fair transmission of monetary policy
2010–2016Base RateCost-plus approach, better than BPLR but still sluggish transmission
April 2016–2019+MCLRDynamic, market-linked, transparent, monthly review of lending rates
Post Oct 2019External Benchmark SystemLoans linked to repo/T-bill yield, fully market-driven, transparent

What is MCLR?

The Marginal Cost of Funds based Lending Rate (MCLR) is the minimum internal benchmark interest rate that a bank can lend at for various tenors (overnight, 1 month, 6 months, 1 year, etc.), except in cases allowed by the RBI (e.g., certain priority sector loans, government schemes).

It represents the actual incremental cost to a bank for arranging funds, factoring in interest paid on deposits, borrowings, and other liabilities, instead of just averaging the cost of all existing funds (as done in the Base Rate system).

RBI’s Definition of MCLR:

“MCLR is the minimum lending rate below which banks are not permitted to lend, except in certain cases allowed by the RBI.”

Core Components of MCLR Explained

MCLR is a multi-variable calculation, making it a more accurate indicator of market lending costs.

ComponentExplanation
1. Marginal Cost of FundsCost of new deposits and borrowings, and return on net worth (equity capital). This is the largest component (~92%).
2. Negative Carry on CRRCost banks bear for maintaining mandatory reserves with RBI, on which no interest is earned.
3. Operating CostsIncludes expenses like salaries, administrative costs, branch operations (excluding provisions for bad loans).
4. Tenor PremiumAdditional risk-based cost for long-term loans. A 5-year loan carries higher risk than a 6-month loan, hence higher MCLR.

Marginal Cost of Funds

  • Cost of Borrowings:
    • Interest rates on recent term deposits, interbank borrowings, bonds, etc.
  • Return on Net Worth:
    • RBI allows a return of 8% on Tier I capital as the bank’s expected return.
  • Weightage:
    • 92% weightage to Marginal Cost of Borrowings
    • 8% to Return on Net Worth

This ensures that banks cannot use cheap legacy deposits to underprice new loans. Instead, MCLR aligns more closely with current funding conditions.

Negative Carry on CRR

Banks are mandated to maintain 4.5% of NDTL (Net Demand and Time Liabilities) with the RBI as Cash Reserve Ratio, earning 0% interest. This is a cost to banks, and is included in MCLR.

Operating Costs

Covers all non-interest-related expenses in loan operations:

  • Infrastructure
  • IT & digital systems
  • Salaries
  • Branch costs
  • Legal and compliance expenses

Notably, it excludes provisions for NPAs (Non-Performing Assets).

Tenor Premium

  • Reflects the risk and uncertainty of longer-term loans.
  • For instance, banks may charge a premium of 10–30 basis points for a 3-year loan compared to a 6-month loan.

Calculation Methodology of MCLR

Formula:

MCLR = Marginal Cost of Funds + Negative Carry on CRR + Operating Costs + Tenor Premium

Let’s break this down with a simplified example:

ComponentRate (Example)
Marginal Cost of Funds7.25%
Negative Carry on CRR0.15%
Operating Costs0.20%
Tenor Premium (1 Year Loan)0.10%
Final 1-Year MCLR7.70%

Each bank publishes these rates for multiple tenors like Overnight, 1M, 3M, 6M, and 1Y.

Why Did RBI Introduce MCLR?

The RBI moved from the Base Rate to MCLR to:

  • Improve transparency in bank lending rates.
  • Ensure faster transmission of RBI’s repo rate cuts to end borrowers.
  • Reflect the actual cost of fresh funds raised by banks.
  • Make the lending process responsive and fair to both consumers and businesses.

MCLR vs Base Rate

CriteriaMCLRBase Rate
Basis of calculationMarginal cost of fresh fundsAverage cost of existing funds
Transmission speedFasterSlower
TransparencyHigherModerate
Reset frequencyMonthlyQuarterly
Introduced inApril 2016July 2010
Impact on borrowersQuick benefit from repo cutsDelayed benefit

Applicability of MCLR

  • All new loans (housing, personal, car, education, MSME) from April 1, 2016, were to be MCLR-linked.
  • Existing loans on Base Rate could be migrated to MCLR on request, subject to terms and fees.
  • Reset period:
    • Most MCLR-linked loans have a 6-month or 1-year reset clause, meaning the interest rate adjusts at the end of the reset period, not immediately.

MCLR and Spread

Banks add a “spread” (markup) over MCLR based on:

  • Credit risk premium (borrower’s profile, CIBIL score)
  • Product premium (loan type)
  • Tenor premium

Example:
If 1-year MCLR = 8% and spread = 0.50%, your interest = 8.50%

Illustrative Example of a Home Loan under MCLR

Let’s say you take a home loan of ₹50 lakhs on 1-year MCLR:

  • MCLR (1 Year):
    • 8.25%
  • Spread:
    • 0.50%
  • Effective Interest Rate:
    • 8.75%
  • Reset Period:
    • 1 year
    • After 1 year, if MCLR drops to 7.75%, your new rate becomes 8.25%

Loan Types Affected by MCLR

Loan TypeLinked to MCLR?Current Status
Housing LoansYes (until 2019)Now repo-linked (EBLR)
Personal LoansYes (until 2019)Now repo-linked
Education LoansYesTransitioning to repo-linked
Vehicle LoansYesTransitioned
MSME LoansYesRepo-linked since 2019
Corporate Term LoansMostly MCLR-linkedRemain under MCLR or negotiated pricing
Agricultural Term LoansNot MCLR-linkedUsually subsidized under interest subvention
Fixed-rate LoansNoMCLR not applicable

Why MCLR Still Failed in Full Policy Transmission?

Despite its improvement over Base Rate, MCLR still had limitations:

  1. Banks controlled internal parameters like spread and tenor premium.
  2. Reset periods delayed the passing of rate cuts.
  3. Existing customers didn’t benefit unless they switched loans.
  4. Conversion to MCLR from Base Rate involved fees and paperwork.
  5. RBI realized that external benchmarks were needed for full transparency.

Shift from MCLR to External Benchmark Lending Rate (EBLR)

In October 2019, RBI made it mandatory for all new floating rate loans in the retail and MSME sector to be linked to:

  • RBI Repo Rate
  • 3-month/6-month T-Bill yield
  • FBIL’s published benchmark

This move ensured full and quick transmission of repo rate changes to borrowers.

MCLR continues for:

  • Existing loans
  • Fixed-rate products
  • Corporate loans and select legacy accounts

Use Cases of MCLR in the Real World

  • Home Loans:
    • Most banks offered MCLR-linked home loans until 2019.
  • MSME Loans:
    • MCLR was extensively used in working capital and term loans.
  • Educational Loans:
    • Offered at MCLR + spread.
  • Auto Loans:
    • MCLR-based loans were standard before EBLR.

Impact of MCLR on the Indian Economy

Positive Impacts:

  • Improved policy transmission
  • Enhanced borrower awareness
  • Competitive loan pricing
  • Encouraged banks to improve cost management

Negative Impacts:

  • Partial transparency (banks still manipulated spreads)
  • Delayed rate changes due to reset clauses
  • Borrower confusion during transitions

Visual Representation: Interest Rate Benchmark Evolution

BPLR (2003) → Base Rate (2010) → MCLR (2016) → EBLR (2019+)

↑ Less Transparent        ↑ Moderate             ↑ Transparent
↑ Arbitrary Pricing       ↑ Fixed Margin         ↑ Market-Driven
↑ Poor Transmission       ↑ Delayed Reset        ↑ Real-Time Rate Cuts

Summary

ParameterDetails
Introduced ByRBI (April 2016)
Applicable ToRetail & corporate loans (now only legacy + corporate)
Key FeatureReflects cost of fresh funds
Linked ToInternal benchmarks (not external rates like repo)
Current RelevanceStill applicable for older loans and certain large borrowers
Most Beneficial ForBorrowers with high MCLR drop and short reset period

Conclusion

The MCLR framework was a necessary transitional reform in India’s interest rate regime. While not perfect, it laid the groundwork for the more market-friendly External Benchmark Lending Rate (EBLR).

Today, MCLR is still relevant for:

  • Existing borrowers who have not switched to EBLR.
  • Certain fixed-rate and specialized corporate products.

For new retail borrowers, external benchmarking is now the standard.

Bonus: Key Terms Glossary

TermMeaning
MCLRMinimum internal lending rate based on marginal cost
CRRCash Reserve Ratio, part of funds banks keep with RBI
Tenor PremiumHigher cost added for longer-term loans
Reset PeriodTime interval after which floating interest rates are revised
SpreadBank’s markup over MCLR based on borrower/product
Repo RateRBI’s lending rate to commercial banks
EBLRExternal Benchmark Linked Lending Rate

Popular Online Live Classes

AIC Crash course 2025

AIC 2025 Crash Course & Test Series

Rs 1500.00

rbi 2025 mentorship and test series

RBI 2025 Mentorship & Test Series

Rs 2499.00

NABARD 2025 Mentorship and Test Series

NABARD 2025 Mentorship & Test Series

Rs 2999.00

Popular Bundle & Interview Guidance

nabard and rbi bundle mentorship and test series 2025

NABARD and RBI Combo Mentorship and Test Series 2025

Rs 4500.00

NABARD interview guidance tips and tricks

NABARD interview guidance tips and tricks

Rs 000.00

How to Prepare for NABARD & IBPS AFO Together?

Join our FREE NABARD & IBPS AFO 2025 Webinar and discover expert tips, smart prep strategies, and the secret to cracking both exams together!

View Completed Webinar

Click to reserve your seat for the RBI Grade B 2025 Winning Formula Webinar.

Most Recent Posts

  • All Posts
  • Agri Business
  • Agriculture
  • AIC
  • Answer Key
  • Banking/Finance
  • Bill and Amendment
  • Blog
  • Current Affairs
  • Cut-off Mark
  • Daily Quiz
  • Economy
  • Fact To Remember
  • General
  • International Affairs
  • International Relationships of India
  • IRDAI
  • Job Notification
  • NABARD Grade A
  • National Affairs
  • NICL
  • Organization
  • PFRDA
  • Preparation Tips
  • Previous Year Question Papers (PYQ)
  • RBI Grade A
  • RBI Grade B
  • Recruitment Notification
  • Result
  • Scheme & Yojna
  • Sci & Tech
  • SEBI
  • Study Material
  • Syllabus & Exam Pattern
  • UIIC
  • UPSC Exam
    •   Back
    • RBI Previous Year Question Papers (RBI PYQ)
    • SEBI Previous Year Question Papers (SEBI PYQ)
    • IRDAI Previous Year Question Papers (IRDAI PYQ)
    • NABARD Previous Year Question Papers (NABARD PYQ)
    • SIDBI Previous Year Question Papers (SIDBI PYQ)

Month-Wise Current Affairs

Category

Read More....

  • All Posts
  • Agri Business
  • Agriculture
  • AIC
  • Answer Key
  • Banking/Finance
  • Bill and Amendment
  • Blog
  • Current Affairs
  • Cut-off Mark
  • Daily Quiz
  • Economy
  • Fact To Remember
  • General
  • International Affairs
  • International Relationships of India
  • IRDAI
  • Job Notification
  • NABARD Grade A
  • National Affairs
  • NICL
  • Organization
  • PFRDA
  • Preparation Tips
  • Previous Year Question Papers (PYQ)
  • RBI Grade A
  • RBI Grade B
  • Recruitment Notification
  • Result
  • Scheme & Yojna
  • Sci & Tech
  • SEBI
  • Study Material
  • Syllabus & Exam Pattern
  • UIIC
  • UPSC Exam
    •   Back
    • RBI Previous Year Question Papers (RBI PYQ)
    • SEBI Previous Year Question Papers (SEBI PYQ)
    • IRDAI Previous Year Question Papers (IRDAI PYQ)
    • NABARD Previous Year Question Papers (NABARD PYQ)
    • SIDBI Previous Year Question Papers (SIDBI PYQ)

C4S Courses is one of India’s fastest-growing ed-tech platform, dedicated to helping students prepare for premier entrance exams such as NABARD Grade A and RBI Grade B.

Exam

RBI Grade B
NABARD Grade A

Download Our App

Copyright © 2024 C4S Courses. All Rights Reserved.