Implementation of MCLR Regime

Implementation of MCLR Regime

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A benchmark interest rate known as the marginal cost of funds-based lending rate (MCLR) is the minimum rate that banks are permitted to lend at. In essence, the base rate system that had been in place up until that point was abolished when MCLR came into effect in 2016. The Reserve Bank of India (RBI) was the first to introduce MCLR rates in order to guarantee banks better pricing for floating rate loans to end customers. Its primary objective was to strike a balance between the interests of the banking system through a benchmark rate that could guarantee profitability and the transmission of interest rate benefits from the RBI's monetary policy to borrowers.

Another important fact to know is that MCLR is a bank's "internal benchmark" and is linked to tenor, or the amount of time left to pay back a loan. Currently, commercial banks use it as the lending rate for some of their loans, and each bank sets it independently. What is MCLR and why was it put into place? - By enhancing transparency in the lending process, MCLR aims to create a win-win situation for both the borrower and the lender.

For instance, in the past, banks did not have to lower their interest rates when the RBI cut rates during its regular policy meetings. On the other hand, whenever the RBI raised policy rates, lenders were criticized for raising rates quickly. Even with the introduction of the base rate system in 2010, this delay in transferring interest rate cuts from the RBI to borrowers has persisted. With monthly updates to the MCLR, the RBI's interest rate revisions can be transmitted to the borrower relatively quickly. To put it another way, it helps borrowers reap the benefits of the RBI's rate cut more quickly.

In addition to speedy transmission, bringing MCLR also sought greater transparency. A bank would charge customers a "spread" over the base rate based on a variety of factors, including loan category, customer type, and so on, in the earlier base rate system. whose conclusion was not particularly scientific or uniform. For instance, a bank would charge customer A a rate of 9.5% (base rate plus 0.5 percent spread) and customer B a rate of 9.75% (base rate plus 0.75% spread). The spread in the MCLR is set to be fixed based on the customer's riskiness and the length of the loan. Changes are only allowed if the sanction document and the borrower's risk profile change significantly.