The base rate system was introduced by the Reserve Bank of India (RBI) in July 2010 to make sure that banks and Non-Banking Financial Companies (NBFCs) can lend to customers only above a prescribed threshold. However, over time, a few loopholes emerged in the system. The primary goal of ensuring effective transmission of the change in interest rates to borrowers was not achieved. To bring more efficiency into the system, the RBI then replaced the base rate system with the Marginal Cost of Funds Lending Rate or MCLR in April 2016. Let us learn more about what the MCLR is and its implications on borrowings.
What is MCLR?
The MCLR is a standard lending rate for banks and other leading organizations to provide money to borrowers. It is directly linked to the actual deposit rates. As per the MCLR, the bank or NBFC is required to submit up to five rates to the RBI including rates for one-year MCLR, six-month MCLR, and three-month MCLR as well as for shorter periods with the one-month MCLR and overnight MCLR. The calculation of MCLR involves the following factors:
Difference between MCLR and Base Rate
Let’s have a look at the difference between MCLR and Base rate
|The base rate is based on average cost of funds||MCLR is based on marginal/incremental cost of funds|
|It is calculated by considering minimum rate of return/profit margin||MCLR is calculated by considering tenor premium|
|Base is also governed by operating expenses, and expenses needed to maintain cash reserve ratio||The MCLR is also determined by considering deposit rates and repo rates, along with operating costs and cost of maintaining cash reserve ratio.|
Do mclr affect other loans?
All floating rate loans and credit renewal are based on the MCLR. For existing borrowers, there will be an option to switch over to the MCLR system. Floating rate loans include:
- Home loans
- Loans against property
- Corporate term loan
MCLR rate is closely linked with the repo rate and fund costs of the banks. Thus, MCLR in home loans has an impact on your home loan’s floating rate of interest. If a bank brings down the marginal cost of funds based lending rate, the floating rate of interest associated with your MCLR rate home loan also goes down. This will not be affecting your equated monthly installments (EMI) but the tenure of the loan will have an impact. Also read if mclr cut reduce your home loan burden only at Finserv MARKETS
The marginal cost of funds
The marginal cost of funds is the fee associated with the bank offering one additional loan keeping in mind that the overall cost for providing the loan remains the same. It is computed as the equivalent of 92% of the marginal cost of borrowing in addition to 8% of the return on net worth.
The cash reserve ratio
The cash reserve ratio or CRR denotes the minimum amount of the total customer deposits that the institution must keep with the RBI. This particular amount cannot be used by the bank for revenue generation or investments. It is termed as the negative carry.
The tenure premium
The factor refers to the direct proportion of the tenure or length of the loan to the amount of premium required to furnish it. It ensures that the premium amount is uniform for any kind of loan offering if the residential tenure remains the same.
The operating cost includes the cost of the funds and the associated costs for the bank to furnish the loan amount to the borrower. The one-year MCLR is calculated as the equivalent of the result of the interest rate on one-year term deposits, CRR, tenure premium, and operating costs.
Now that we are empowered with the knowledge on the calculation of the MCLR, let us take a look at how this affects you.
The MCLR is not associated with borrowings such as a fixed interest home loan. However, the system is linked to the floating home loan system. The floating interest rate is a type of rate that varies depending on market conditions and rates. It comprises of a base rate that remains constant and a floating component that is variable in nature. In the case of a floating rate home loan, the Equated Monthly Installment or EMI comprises of the principal component and base rate in addition to the floating element that could fluctuate depending on the market. Your home loan interest rate would largely rely on the reset period chosen by the bank – whether a six-month MCLR or one-year MCLR. Therefore, the benefits arising from the changes in the bank rate will only be evident at the end of the reset period.
Banks often offer lower interest rates when borrowers opt for the floating rate interest. However, you must keep in mind that the rates might not remain low for longer periods of time and could have a detrimental effect on your finances. The best way to access a home loan, therefore, is to increase the EMI amount and as a result lower the repayment period. At the commencement of the loan, you could opt for a longer repayment tenure and make the switch when your finances allow for adequate repayments.
Before selecting a home loan product, you should scout through the available offerings on leading platforms such as Finserv MARKETS. The digital platform hosts home loan products such as the Bajaj Finserv home loan. The Bajaj Finserv home loan interest rates are competitive and work to reduce the financial burden associated with borrowings. While taking on a home loan, you should weigh out the benefits of the plan against the fee, time, and effort associated with the investment.
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