Did you know that the ‘Marginal Cost of Funds based Lending Rate’ is a key determinant of the rate of interest on your loan?

When you compare the suitability of a loan for yourself as an individual or a business, the biggest influencer in your decision is the rate of interest being offered by the financial institution. As you may have noticed, the difference in rates of interest offered by lending banks tends to be marginal. When you take a small value loan that difference may not impact your decision of which financial institution you choose. But when you take a large business loan or a high-value LAP, even a basis point variation in the lending rate can save you thousands of rupees in interest payments each year.

Ever wondered what determines the interest rate at which a bank is lending to you? Well, the biggest influencer is the RBI mandated Marginal Cost of Funds based Lending Rate (MCLR).

The MCLR is the minimum rate at which an RBI recognized bank or financial institution can lend to borrowers. When the MCLR drops, customers can avail loans from banks at a lower rate of interest.

The MCLR is a relatively new concept in the Indian banking system. It was introduced by the RBI on 01 April 2016 to check the lending behaviour of banks and financial institutions. Before this, banks were loosely pegging the loan interest rates on the Base Rate. The MCLR ensures that the benefit of a lower repo rate (the rate at which banks borrow from RBI) is passed on to borrowers.

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Yes, the MCLR rates vary across lending banks and financial institutions. Apart from the MCLR communicated by RBI, the actual MCLR rates offered by a bank or financial institution is determined by the following factors.

Changes in MCLR only affect loans that are on floating interest rates and not fixed rates of interest.

When this happens, the EMI on loans (with floating interest rates) increases. In this case, as a borrower, you can make a part pre-payment to lower the EMI burden.

The MCLR is a dynamic interest rate. Banks and financial institutions are required to publish their MCLR rates for different loan maturities every month. Borrowers who have taken large loans before April 1, 2016, may benefit from switching to loans that are based on MCLR.

There are two options – you can either approach your existing bank to switch your loan from the base rate to the MCLR or you can approach another lending institution that offers loans at MCLR to take over your loan (also known as refinance and balance transfer).

Yes, the MCLR also has an inherent drawback – it is not immediately responsive to changes in the repo rate. Banks can take 6 to 12 months to effect a change in the MCLR due to a change in the repo rate.

To combat this lag, the RBI introduced the concept of repo linked lending rate (RLLR) from October 1, 2019.

RLLR or repo linked lending rate (like the MCLR) is also linked to the changes in the repo rate. However, there are two differences which can make taking an RLLR loan better for retail customers –

1. The RLLR is adjusted almost as quickly as the changes in the repo rate. This is unlike the MCLR which can take many months to change.

2. The RLLR offered by banks is determined by the repo rate and factors pertaining to the individual borrower, such as the value of the loan and the risk-group of the borrower. The MCLR on the other hand is linked to many other factors that are external to the borrower (refer chart above).

Therefore, all things equal, an RLLR loan will be cheaper than an MCLR loan, especially in a market where repo rate is expected to fall.