Marginal Cost of Funds Lending rate ... Is it a big deal or what?

Today we would discuss about the Marginal Cost of Fund based Lending Rate - MCLR rate and whether it is better then the previously used base rate by bank rate. Also, is it advised to shift the existing loan to MCLR rate, which is applicable from 1^st April 2016.

What is MCLR rate?

MCLR is the new internal benchmark lending rate which is adopted by the lending banks on the floating loans provided by them. Every bank is suppose to declare minimum MCLR rates during a year. These rates would largely be affected by change in repo rate announced by RBI and pass on the benefit of lowering of interest rates to customers. It would largely affect the floating loan products and not touch the fixed rate products of the bank.

This benchmark rate is calculated on four basic parameters (from the perspective of the bank):

1. Marginal Cost of funds – it is basically the difference between the cost of obtaining funds from RBI i.e. Repo rate and cost of lending loans to the customers.
2. Cost of maintaining CRR- Every bank needs to maintain a certain liquid reserves with RBI as a safety net for their customers. The RBI doesn't provide any interest on these funds. Thus, the cost of this reserve is to be adjusted in the expenses of the bank, which gradually passes on to the customers.
3. Operating costs – it is the cost of running a bank like any other entity. It is zeroed down to per customer or per 100 rupee loan.
4. Tenure of loan – the longer the duration of loan, higher is the interest charged by the bank. It is more economical in terms of running a bank as it reduces the overall cost.

Why this change in benchmark rate?

1. More clarity in terms of lending rate ,unlike in base rate where every bank could fix its own borrowing rate.
2. Previously under the base rate system, banks only occasionally changed the base rate. The corresponding reduction in their base rate was only after huge change in repo rates . Under MCLR, banks are obliged to readjust interest rate regularly.
3. Under MCLR, the cost of lending is a major component affecting the new rates and so, the banks cannot charge a huge spread.
4. Also, now no longer can any bank add the concept of minimum return to its cost burdening the lender.

Will it affect the home loan EMIs?

Under the new system, all fresh loans bought after 1^st April 2016, is definitely following this methodology for calculating the EMI. Even the old or existing loans as on that date can move their loan to this new system if desired. Under the MCLR regime, the rate gets revised at a fixed predefined date. So, if a particular contract mentions that the interest rate would be revised and accordingly, even the EMI of the loan. However, if the interest follows an uptrend, it could mean an increase in the monthly installments.

Our opinion

MCLR is effective for short term lending, however in long tenure the lending would remain largely unaffected. So, although MCLR is boon for optimistic people believing in interest downtrend, it is not a one way road for the loan takers.

Regards

Saarthi Financial Planners