MCLR: A complete guide to understanding lending rates in India

Confused by acronyms like MCLR and EBLR when seeking a home loan? It is time to clear the financial fog. Knowing what they mean saves money on your property purchase. This article explains these lending rate benchmarks in simple terms – whether set by the RBI or banks themselves. 

In this article, we have explained the terminology in simple words to help you make affordable borrowing decisions. Let’s get started!

Also read:RBI MPC meeting: Repo rate unchanged, what does it mean for you?

What is MCLR?

MCLR’s full form is Marginal Cost of Funds Based Lending Rate. The MCLR decides the interest rate on consumer loans, like home loans. It is an internal standard that is tied to a period. Commercial banks’ lending rates are determined by MCLR rather than the previous base rate structure.

In 2016, the RBI introduced the MCLR to calculate loan interest rates. To set interest rates on loans, it serves as an internal benchmark rate for financial institutions. 

After MCLR is in place, interest rates are determined based on a customer’s relative risk factor. In the past, it took banks a while to adjust their lending rates following the RBI’s reductions to the repo rate.

When the repo rate changes, banks are required under the MCLR regime to update the interest rates immediately. One goal of the change is to make the process by which banks determine the interest rate on loans more transparent.

As a bonus, it guarantees that both customers and banks may look forward to bank credits with transparent interest rates.

Also read:Bank rate vs. Repo rate – Understanding the key differences

MCLR rate

MCLR was created to fix problems with the base rate system and make it easier for people to get loans including home loans. Banks and other financial organisations used to provide particular advantages to their top clients when lending on base rates was the norm.

For instance, some banks would offer prime customers loans at 7% or lower if that was the benchmark lending rate. That same rate of interest might have been 10-12% for regular consumers.

Because the base rate was the bank’s strategy, this led to a considerable loss of money. It took financial institutions a long time to reduce lending rates and pass the benefits on to consumers despite rate cuts.

MCLR calculation: How to calculate MCLR?

The formula for calculating MCLR is:

MCLR = MCOF + Negative Carry on CRR + Operating Costs + Tenor Premium

Here,

Marginal Cost of Funds (MCOF): According to this, this is how much more it costs the bank to get additional funds. It includes the cost of savings, loans, and other ways to get funds.

Negative Carry on Cash Reserve Ratio (CRR): Banking institutions in India keep a certain amount of their savings in cash reserves with the RBI. These accounts do not make interest. The negative carry-on CRR is the cost of this cushion that isn’t making any earnings.

Tenor premium: For the length of the loan, banks add more to the MCOF since loans with longer terms usually come with more risk. The usual duration of a bank’s debts is used for calculating this price.

Operating costs: This includes things like rent, bills, staff fees, and other costs that the bank has to pay to run its business.

What is RBLR, RRLR, and EBLR?

Repo rate linked lending rate (RRLR)

The lending rate that is tied to the Reserve Bank of India’s repo rate is called the repo-linked lending rate. 

The effective RRLR interest rate, however, is conditional on several variables. For instance, the interest rate on an RRLR-linked property loan will vary depending on several criteria, including the loan size, the loan-to-value ratio, and the applicant’s risk category.

Banks pay the repo rate when they borrow money from the Reserve Bank of India. Banks reduce their lending rates when the Reserve Bank of India lowers the repo rate. So, if the loan is based on RRLR, the interest rate on the house loan will go up or down in parallel with the repo rate.

Also read: Top 5 high-yield investment opportunities and risks

Repo-based lending rate (RBLR)

Some financial institutions base their loan interest rates on repo-based lending rates, or RBLR for short. A bank’s ability to borrow money from the Reserve Bank of India (RBLR) is directly related to the repo rate.

Whenever the RBI changes the repo rate, the RBLR is immediately adjusted. 

External benchmark lending rate (EBLR)

When setting interest rates on loans, financial institutions often look to the External Benchmark Lending Rate (EBLR).

To ensure that lending rates follow policy changes in real time, the external benchmark linked rate (EBLR) replaces the MCLR. In 2019, EBLR was introduced to address the issues of MCLR, which had been criticised for transmitting data slower than expected. 

While MCLR was the standard for home loans, EBLR has now begun to replace it with other retail products, including personal loans and education loans.

RBLR vs MCLR

MCLR vs RRLR

MCLR vs EBLR

Conclusion

Ultimately, familiarity with interest rate levers makes home finance less daunting. MCLR, EBLR, and RBLR may seem complicated, but they may influence your property purchasing power. 

Though complex-sounding, better clarity will allow you, as a borrower, to spot affordable options, potentially saving a significant amount over the years.