The Marginal Cost of Funds based Lending Rate (MCLR) system was introduced by the Reserve Bank to provide loans on minimal rates as well as market rate fluctuation benefit to customers. This new system has modified the existing base rate system of providing home loans.
MCLR is based on the risk taking capacity of borrowers, where banks prepare marginal cost of funds lending rates. Unlike base rate regime, these rates are expected to get revised on monthly basis along with the repo rate including other borrowing rates. Banks decide the actual lending rate based on the floating rate by adding the component of spread to MCLR which becomes the final lending rate.
In this new system, banks have to set various benchmark rates for specific time periods starting from an overnight to one month, quarterly, semi-annually and annually.
MCLR depends upon four components – marginal cost of funding, tenor premium, operating cost and negative carry account of credit reserve ratio. The four components of MCLR are:
This is the cost charged on the interest rate given on term deposits, savings, and current account, etc. The cost is also charged on the borrowings and return on net worth.
Negative carry account of CRR
It mostly arises if the actual return is less than the cost of the fund.
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It is simply the operational expenses evolved by the banks during the process.
It means the higher interest charged on long term loans which are equal for all types of loans.
Here are 5 things to know about the MCLR regime:
1. Is the tenor premium charged for residual tenor or contractual tenor?
As the floating rate loans are subject to periodic resets, the tenor premium is an appropriate premium for the residual period up to the next reset date.
2. What is the denominator used for arriving at the operating cost for computing MCLR?
Mostly, banks do calculate all operating costs as a percentage of the marginal cost of funds for computing MCLR.
3. Can components of spread be negative?
The components of the spread that is, a business strategy and credit risk premium cannot be negative. It has either a positive value or a zero value.
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4. Will the refinanced loans be permitted under MCLR system?
Banks give fixed rate loans to long term projects where initial debt facility consists of a loan for a medium term, say 5 to 7 years. They can give fixed rate loans to long term projects where the interest rates are fixed till the loan is due for refinancing. At the time of refinancing, the loan will be treated as a fresh fixed rate loan with a new maturity period equal to the period up to the next date of refinancing.
5. Will the interest rates on fixed rate loans or the fixed portion of hybrid loans be based on the date of sanction or disbursement?
The interest charged on fixed-rate loans as well as the fixed portion of hybrid loans is the interest rate which is mentioned in the sanction letter.
(With Inputs from RBI)