In the year 2010, the Reserve Bank of India set a minimum rate for banking and non-banking companies (NBFCs) below which they were not allowed to lend loans to their customers. However, some financial experts found certain loopholes in the Base Rate System as a result of which, in 2016, the Marginal Cost of Fund Based Lending Rate (MCLR) was introduced. Since there was a gap of almost 6 years between these two rate systems, the people who had already taken a personal loan at the base rate were presented with an option to switch to MCLR or continue with the base rate. However, the decision of choosing between MCLR and base rate could be confusing for some people as there is not enough clarity on the two terms. The following article can help shed some light on the concept-
The base rate replaced the ‘Benchmark Prime Lending Rate’ (BPLR) to be the minimum interest rate below which the banks or NBFCs cannot grant a loan. The main objective of introducing a base rate was-
To ensure a high level of transparency in the lending rate selection approach by banks and NBFCs
To enhance the transmission of monetary policies
By adhering to the RBI norms, all the banks are free to determine their own base rate depending on factors such as average cost of funds, profit margins, operating costs, negative carry in the cash reserve ratio, etc.
Marginal Cost of Fund Based Lending Rate
The Marginal Cost of Fund Based Lending Rate (MCLR) is the current governing interest rate for all types of loans in India. Right now, the MCLR is the lowest rate, in accordance to which banks and NBFCs are allowed to grant loans. The MCLR is applicable only on floating interest rate and financial institutionscan only grant a loan below it after taking special allowance from the RBI.
The key benefits of MCLR are:
Any loopholes under the base rate system are overcome
It ensures that all banks and NBFCs follow the uniform policy rates
Under the MCLR system, all banks and NBFCs submit 5 distinct MCLRs every year. These 5 rates include-
- One year MCLR
- Six Month MCLR
- Three-month MCLR
- One month MCLR
- Overnight MCLR
Difference between MCLR and Base Rate:
The Bottom Line: What to choose?
Switching from base rate to MCLR can definitely prove advantageous as the rate of interest is much less when compared to the base rates. Change of interest rate cycle in case of MCLRs (yearly, overnight, six months, etc.) can further reduce the burden of your interest rates. However, one must be aware of the costs of legal fees, processing fees, stamp duty, etc while shifting the loan from base rates to MCLRs. If the borrowers feel that these charges could prove burdensome, they can choose to continue at the existing base rates.
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You can read about RBI guidelines for home loans. Also, get more information on how can you get a lower interest rate on your personal loan.
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