The Marginal Cost of Funds-based Lending Rate (MCLR) is a benchmark interest rate system introduced by the Reserve Bank of India (RBI) in April 2016. It was implemented to replace the older base rate system to ensure better transmission of monetary policy decisions. MCLR is essentially the minimum interest rate that banks can offer to their borrowers, as it reflects the cost incurred by banks in funding loans.

MCLR plays a crucial role in determining the interest rates on personal loans. Since personal loans often come with floating interest rates, any change in the MCLR directly impacts the rates borrowers will pay. When the MCLR increases, the interest rate on the loan also increases, leading to higher EMIs (Equated Monthly Installments). Conversely, if MCLR decreases, the interest rates fall, benefiting the borrower with lower EMIs.

In this blog, we will discuss what MCLR is, how it is calculated, and its importance in determining personal loan interest rates. We will also explain the differences between MCLR and the previous base rate system and how MCLR impacts both new and existing loans. The goal of this blog is to give you an insightful understanding of MCLR and how it affects your personal loan decisions, especially when considering floating interest rates.

What is MCLR?

MCLR is a dynamic interest rate framework that reflects the marginal cost of funds for a bank. Unlike the previous base rate system, which was not as sensitive to monetary policy changes, MCLR adjusts more quickly to changes in the RBI’s policy rates, particularly the repo rate. This allows borrowers to benefit from interest rate reductions sooner, while banks also remain aligned with the cost of funds.

Key Objectives of the MCLR System

The main objectives behind introducing the MCLR system were:

1. To improve transparency in the lending process.
2. To ensure that borrowers benefit from changes in monetary policy more effectively.
3. To bring uniformity in the way interest rates are calculated across different banks.

Difference Between MCLR and Base Rate

The base rate system, which was replaced by MCLR, had its limitations. It was less responsive to changes in the RBI’s repo rate (the rate at which RBI lends to commercial banks). As a result, borrowers did not always benefit from reductions in the repo rate. In contrast, the MCLR system is more directly linked to the cost of funds for the bank, making it more sensitive to repo rate changes.

For example, under the base rate system, if the RBI reduced the repo rate by 50 basis points (0.5%), banks were not obligated to pass on the reduction immediately. However, with MCLR, any such reduction has a direct impact on the bank’s cost of borrowing, encouraging banks to revise lending rates more frequently.

How MCLR is Calculated

MCLR is calculated based on four key factors that reflect the bank’s cost of lending. These components are:

1. Marginal Cost of Funds:
   • This is the most significant component and includes the interest rate on deposits and the cost of borrowing. It reflects the cost that banks incur to fund loans.
2. Negative Carry on CRR (Cash Reserve Ratio):
   • Banks are required to maintain a portion of their deposits with the RBI as CRR. Since these funds do not earn any interest, there is a negative impact on the bank’s earnings, which is factored into the MCLR.
3. Operating Costs:
   • These are the costs incurred by banks to operate their lending business, such as staff salaries, branch maintenance, and IT infrastructure.
4. Tenor Premium:
   • Longer-term loans carry higher risks, which is why banks charge a tenor premium. It compensates for the increased risk of lending over a more extended period.

Types of MCLR Rates

Banks typically offer different MCLR rates depending on the loan tenure. These are:

• Overnight MCLR: Applicable for very short-term loans.
• 1-month MCLR: For loans with a one-month tenure.
• 3-month MCLR: Loans with a tenure of three months.
• 6-month MCLR: Loans with a six-month tenure.
• 1-year MCLR: Applicable to loans with a one-year term or more.

Each of these rates is revised by banks periodically, usually on a monthly or quarterly basis, depending on their policies.

Why MCLR is Important for Borrowers

For personal loan borrowers, especially those opting for floating interest rates, it is essential to understand MCLR. Since MCLR determines the minimum interest rate banks can charge, any fluctuation in MCLR will impact their EMI payments. Borrowers must keep track of their bank’s MCLR rates, especially if they have loans with a floating rate clause, to anticipate potential changes in their monthly obligations.

How MCLR Affects Personal Loan Interest Rates

Fixed vs. Floating Interest Rates

When taking a personal loan, borrowers often have the option to choose between fixed and floating interest rates. Fixed interest rates remain constant throughout the loan tenure, providing stability in terms of EMI payments. Floating interest rates, on the other hand, fluctuate based on changes in MCLR, meaning that your EMIs can increase or decrease over time.

For instance:

• A fixed-rate personal loan will have the same interest rate and EMI throughout the loan period, unaffected by changes in MCLR.
• A floating-rate personal loan will see its interest rate adjust periodically based on the bank’s MCLR. This means that your EMI could either increase or decrease depending on changes in the MCLR rate.

Impact of MCLR on Personal Loan EMIs

One of the most direct impacts of MCLR on personal loans is on EMI payments. Since MCLR determines the lending rate for floating-rate loans, any change in MCLR will be reflected in the EMI amount.

For example, if you take a personal loan at a floating rate of MCLR + 2%, and the current MCLR is 7%, your effective interest rate would be 9%. If the MCLR later decreases to 6.5%, your interest rate will fall to 8.5%, reducing your EMIs.

Let’s assume you took a personal loan of ₹5,00,000 with an interest rate of 9%. If MCLR reduces by 0.5%, you could potentially save a few hundred rupees per month on your EMI payments.

MCLR and Loan Tenure

MCLR also has an impact on the loan tenure for floating-rate loans. If MCLR decreases, it may result in shorter tenures if you choose to keep your EMI payments the same. Conversely, an increase in MCLR can extend the loan tenure unless you increase your EMI payments.

For instance, if you have a 5-year personal loan at a floating rate, and the MCLR increases during this period, you may either have to pay a higher EMI or extend the loan tenure to accommodate the higher interest payments.

Effect on Existing Loans

Existing personal loan borrowers with floating-rate loans will see their interest rates adjusted based on the MCLR rate during the loan’s reset period. Typically, the reset period is either six months or a year. If MCLR increases during this time, the borrower’s EMI will increase after the reset period. Conversely, if MCLR decreases, they will benefit from lower EMI payments.

Effect on New Loans

For new personal loan seekers, the MCLR rate at the time of taking the loan will determine the initial interest rate. If MCLR is low when the loan is disbursed, the borrower can benefit from lower interest rates and EMIs. However, new loan applicants should remain vigilant about potential increases in MCLR, which could lead to higher EMIs in the future.

Factors That Influence MCLR Rates

Repo Rate

The repo rate is a critical factor in determining MCLR. It refers to the interest rate at which the Reserve Bank of India (RBI) lends short-term funds to commercial banks. When the RBI changes the repo rate, it directly impacts the cost of borrowing for banks, which, in turn, influences the MCLR. For instance, a reduction in the repo rate lowers the cost of funds for banks, which usually leads to a decrease in MCLR. On the other hand, if the repo rate increases, banks may raise their MCLR to compensate for the higher borrowing costs.

Cost of Borrowing

The cost of funds for banks is a major determinant of the MCLR. Banks source funds from deposits and loans, and the cost they incur in securing these funds plays a role in setting the MCLR. Banks with a lower cost of borrowing (for example, banks with higher deposits and lower borrowing needs) can offer a lower MCLR. Conversely, banks that rely heavily on expensive borrowings will have a higher MCLR.

CRR (Cash Reserve Ratio)

The Cash Reserve Ratio (CRR) is the portion of a bank’s deposits that must be held in reserve with the RBI. Since banks do not earn any interest on these reserves, maintaining a high CRR can negatively affect their earnings. This results in a higher MCLR because banks will factor in this “negative carry” when calculating their lending rates. A lower CRR, however, reduces the burden on banks, allowing for a more favourable MCLR.

Bank-Specific Factors

Each bank sets its MCLR rate based on its own internal costs, margins, and market conditions. Factors such as operating expenses, risk premiums, and market competition can lead to varying MCLR rates across banks. For example, banks with higher operational costs or those facing liquidity issues may set a higher MCLR. Conversely, banks with efficient operations and lower borrowing costs may offer lower MCLR rates to attract more borrowers.

MCLR and Personal Loan Borrowers: What to Know

When Does MCLR Apply to Personal Loans?

MCLR primarily applies to floating-rate personal loans. These loans have interest rates that fluctuate based on changes in the MCLR. Borrowers should note that fixed-rate personal loans are unaffected by changes in MCLR, meaning that their EMIs remain the same throughout the loan tenure. However, for floating-rate loans, any change in MCLR will directly impact the loan’s interest rate and, consequently, the borrower’s EMI payments.

How Often MCLR Changes

Banks revise their MCLR rates either monthly or quarterly. The revision frequency depends on the bank’s internal policies, as well as the external economic environment. Personal loan borrowers with floating interest rates should keep track of these changes to understand how their EMIs may be impacted. Being aware of MCLR revisions is crucial for making informed financial decisions.

Impact of MCLR Reset Period

The reset period is a key concept in floating-rate personal loans. It defines the interval after which the interest rate on the loan is revised based on the current MCLR. For example, if the reset period is one year, the loan’s interest rate will be updated only after a year, regardless of any MCLR changes during that period. This means that even if MCLR fluctuates, the borrower’s EMI remains unchanged until the reset period is over. Afterwards, the loan rate is recalculated according to the prevailing MCLR.

Example: Suppose you take a personal loan with a floating rate and a one-year reset period. Even if the bank reduces its MCLR by 0.5% after six months, your EMI will not change until the one-year reset period ends.

Comparison: MCLR vs. Repo Rate Linked Loans

MCLR-Linked Personal Loans

MCLR-linked personal loans are based on a bank’s internal MCLR. The bank sets a margin above the MCLR, which can vary based on its risk appetite and market conditions. This system gives banks more flexibility in determining the final lending rate. While MCLR-linked loans are influenced by repo rate changes, the adjustment is indirect and may not immediately reflect the change in repo rates.

For example, a bank may decide to keep a margin of 2% over the MCLR, which could result in a higher or lower rate based on the MCLR adjustments over time.

Repo Rate Linked Loans

In contrast, repo rate-linked loans are directly tied to the RBI’s repo rate. Whenever the RBI changes the repo rate, the interest rate on these loans is immediately adjusted. This ensures faster transmission of monetary policy decisions to borrowers. Repo rate-linked loans tend to be more transparent, as they directly reflect changes in the repo rate.

For example, if the RBI reduces the repo rate by 0.25%, the interest on repo rate-linked loans decreases by 0.25%, ensuring quick relief for borrowers.

Which is Better for Borrowers?

The choice between MCLR-linked loans and repo rate-linked loans depends on individual preferences and risk tolerance.

MCLR-linked loans offer more flexibility for banks in setting their margins, and changes may not be immediate. However, the interest rate could be lower in certain scenarios depending on the bank’s cost of funds and its ability to offer competitive MCLR rates.

Repo rate-linked loans, on the other hand, offer faster rate adjustments based on changes in the RBI’s repo rate, making them a better option for borrowers who prefer transparency and immediate transmission of rate cuts.

Benefits of MCLR for Personal Loan Borrowers

Transparency in Interest Rates

The Marginal Cost of Funds-based Lending Rate (MCLR) system offers transparency in how banks determine interest rates for personal loans. This transparency benefits borrowers as it clearly reflects the factors that influence the loan’s interest rate, such as the cost of borrowing for the bank, operating expenses, and regulatory requirements. For borrowers, this means that interest rates are no longer arbitrarily decided but are based on a transparent, rule-based system, ensuring that they are more predictable and easier to understand.

Lower Interest Rates in a Falling Rate Environment

One of the significant advantages of MCLR is that it enables borrowers to benefit from lower interest rates when the Reserve Bank of India (RBI) reduces its repo rate. Since MCLR is directly linked to the repo rate, a falling rate environment leads to a reduction in personal loan interest rates. This is particularly beneficial for borrowers who have taken loans on a floating interest rate, as their equated monthly instalments (EMIs) reduce when MCLR drops.

Reduced Cost of Borrowing

Another benefit of MCLR is that it often results in a lower cost of borrowing for personal loans. The competition among banks to offer attractive loan packages drives down MCLR rates, benefiting borrowers with more competitive interest rates. This can lead to significant savings over the life of a personal loan, especially for borrowers who are well-informed about the prevailing MCLR rates and choose the best loan options accordingly.

Drawbacks of MCLR for Personal Loan Borrowers

Delay in Interest Rate Transmission

While MCLR theoretically ensures that borrowers benefit from falling interest rates, there can be a delay in passing on these benefits. Banks do not always reduce their MCLR rates immediately after an RBI repo rate cut. This delay in transmission means that personal loan borrowers may not experience immediate relief in their EMIs, even if the overall interest rates in the economy are falling.

Complexity for Borrowers

Understanding MCLR can be quite complicated for the average borrower. The calculation of MCLR involves several components, such as the marginal cost of funds, operating costs, and a tenor premium, making it difficult for borrowers to track or predict changes. Additionally, different banks may set different MCLR rates for the same loan tenure, which makes it hard for borrowers to compare and choose the best loan. This complexity can confuse borrowers, leading to uninformed decisions when selecting personal loans.

How to Choose the Right Personal Loan Based on MCLR

Check MCLR Trends

Before applying for a personal loan, it’s essential to check the recent trends in the bank’s MCLR. Banks revise their MCLR periodically, and staying informed about these changes can help borrowers choose a loan at the most advantageous time. A low MCLR at the time of loan application can significantly lower the interest rate for borrowers, resulting in affordable EMIs.

Compare Banks’ MCLR Rates

Since each bank sets its own MCLR rates, borrowers should compare the MCLR rates of various banks before finalizing a personal loan. This can help them identify which bank offers the most competitive interest rates. Kreditbazar partners with multiple high-ranking NBFCs and banks, making it easy for borrowers to compare and choose loans with the best possible terms.

Understand the Loan’s Reset Clause

When choosing a personal loan, it’s crucial to understand the reset clause of the loan. The reset period determines how often the interest rate on the loan is adjusted based on changes in MCLR. For example, if the reset period is one year, any changes in MCLR will only affect the loan after a year. Borrowers should be aware of this to avoid surprises in their EMI payments and plan their finances accordingly.

Consider the Bank’s Reputation

When choosing a personal loan based on MCLR, it is also essential to consider the reputation of the bank or NBFC. Banks and financial institutions partnered with Kreditbazar are known for offering competitive interest rates and transparent lending practices, making it easier for borrowers to secure personal loans that meet their needs. Borrowers can trust these institutions to provide reliable and fair loan terms.

MCLR and Its Impact on Credit Scores

How Loan Repayments Are Affected by MCLR Changes

Changes in MCLR directly affect the EMIs of personal loans taken at floating interest rates. When MCLR rises, borrowers may experience higher EMIs, while a decrease in MCLR results in lower EMIs. These fluctuations can impact borrowers’ financial planning. If a borrower struggles to keep up with higher EMIs after an MCLR increase, it could lead to missed or delayed payments.

Effect on Borrower’s Credit Profile

Maintaining a consistent payment record, even with fluctuating EMIs due to MCLR changes, is crucial for a borrower’s credit profile. Timely payments reflect positively on a borrower’s CIBIL score, which is an essential factor when applying for future credit. Borrowers who fail to make regular payments due to increased EMIs risk damaging their credit scores, which can make it harder to obtain loans in the future.

Conclusion

The MCLR system, introduced by the RBI, plays a significant role in determining the interest rates on personal loans. It brings greater transparency and allows borrowers to benefit from lower interest rates in a falling rate environment. However, the delay in the transmission of interest rate cuts and the complexity of understanding MCLR can be challenging for borrowers.

When opting for a personal loan, borrowers should carefully assess MCLR trends, compare banks’ MCLR rates, and understand the loan’s reset clause. Partnering with a reputable bank or NBFC is crucial for ensuring a smooth loan experience. By being informed and proactive, borrowers can choose loans that offer the best possible terms and help them manage their financial obligations effectively.

At Kreditbazar, we partner with leading NBFCs and banks to provide personal loans with competitive interest rates linked to MCLR. Our wide network of lenders ensures that borrowers get the best loan offers tailored to their financial needs. Apply now with Kreditbazar for a hassle-free personal loan experience with transparent terms and flexible options.

Frequently Asked Questions on MCLR Rate and Its Effects on Personal Loans

Q1. What is MCLR?
Ans1. MCLR, or Marginal Cost of Funds-based Lending Rate, is the minimum interest rate below which banks are not allowed to lend, except in some cases. It was introduced by the RBI in 2016 to replace the base rate system.

Q2. How does MCLR affect personal loans?
Ans2. MCLR directly impacts the interest rates on personal loans, particularly those with floating interest rates. Changes in MCLR can result in adjustments to the EMI or loan tenure.

Q3. What is the difference between MCLR and the base rate?
Ans3. MCLR is more dynamic and responsive to changes in the RBI’s repo rate, whereas the base rate system was slower in reflecting these changes. MCLR leads to quicker transmission of monetary policy changes to borrowers.

Q4. How is MCLR calculated?
Ans4. MCLR is calculated based on several components: the marginal cost of funds, operating costs, negative carry-on CRR, and the tenor premium. Each bank calculates its MCLR accordingly.

Q5. How does MCLR affect floating-rate personal loans?
Ans5. In floating-rate personal loans, any change in the bank’s MCLR can lead to a change in the interest rate, and subsequently, the EMI amount can either increase or decrease based on MCLR fluctuations.

Q6. Can MCLR impact fixed-rate personal loans?
Ans6. No, fixed-rate personal loans are not affected by MCLR. The interest rate remains the same throughout the loan tenure, regardless of MCLR changes.

Q7. What are the different types of MCLR rates?
Ans7. Banks offer different MCLR rates based on loan tenures, such as overnight MCLR, 1-month MCLR, 3-month MCLR, 6-month MCLR, and 1-year MCLR. The rate chosen depends on the loan’s repayment period.

Q8. What role does the RBI repo rate play in MCLR?
Ans8. The RBI repo rate directly affects MCLR. When the RBI lowers the repo rate, banks’ borrowing costs reduce, leading to a lower MCLR, which can benefit borrowers with lower interest rates.

Q9. How does MCLR affect EMIs for personal loans?
Ans9. If MCLR decreases, the EMI amount for floating-rate personal loans reduces, and if MCLR increases, the EMI amount goes up. It directly correlates with MCLR changes.

Q10. What is the reset period for MCLR?
Ans10. The reset period is the interval at which the interest rate on a floating-rate loan is adjusted based on the latest MCLR. This period could be every 6 months or annually, depending on the loan agreement.

Q11. How often do banks revise MCLR rates?
Ans11. Banks typically revise MCLR rates monthly or quarterly, depending on internal policies. Borrowers should stay informed about these changes to understand how their loan EMIs might fluctuate.

Q12. What happens to existing personal loans when MCLR changes?
Ans12. For existing floating-rate personal loans, the interest rate is adjusted according to the latest MCLR during the next reset period. Fixed-rate loans remain unaffected.

Q13. How can borrowers benefit from MCLR in a falling interest rate environment?
Ans13. In a falling interest rate environment, borrowers with floating-rate personal loans benefit as MCLR reduces, leading to lower EMIs and overall interest payments.

Q14. Can banks offer different MCLR rates for the same loan tenure?
Ans14. Yes, different banks may set different MCLR rates for the same loan tenure, depending on their cost structures, operating expenses, and market conditions. Borrowers should compare rates across banks.

Q15. What factors influence MCLR rates?
Ans15. MCLR rates are influenced by factors like the RBI’s repo rate, the bank’s marginal cost of funds, the CRR (Cash Reserve Ratio), operating costs, and market conditions.

Q16. What are the drawbacks of MCLR for personal loan borrowers?
Ans16. One drawback is the delay in the transmission of lower rates to borrowers. Additionally, the complexity of the MCLR system and varying rates across banks can make it difficult for borrowers to choose the best loan.

Q17. How can a borrower choose the best personal loan based on MCLR?
Ans17. Borrowers should compare MCLR rates across banks, understand the reset period, check MCLR trends, and choose a bank with a strong reputation for offering competitive rates.

Q18. How does MCLR impact credit scores?
Ans18. Fluctuating EMIs due to MCLR changes can affect a borrower’s payment consistency. Timely EMI payments, despite changes in MCLR, help maintain a good credit score, while missed payments can negatively impact it.

Q19. What is the difference between MCLR and repo rate-linked personal loans?
Ans19. MCLR-linked loans are based on a bank’s internal rate, while repo rate-linked loans are directly tied to the RBI’s repo rate, making them more responsive to repo rate changes.

Q20. Is it better to choose a personal loan based on MCLR or repo rate?
Ans20. The decision depends on a borrower’s preference. Repo rate-linked loans adjust faster to changes in the RBI’s policies, while MCLR-linked loans offer more flexibility for banks in setting interest rates.