Purpose of the MCLR Regime

Purpose of the MCLR Regime

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The RBI introduced MCLR as an alternative to the base rate system. In terms of the broader objective, both the base rate and MCLR set out to achieve the same thing – they enforced the minimum interest rate below which financial institutions cannot lend. The two systems are also different in many ways, but the main point to remember is: MCLR and the base rate are similar in that they both are connected to the cost of borrowing for the bank.

Tenor and Marginal - The difference, however, is that MCLR adjusts for factors that determine the cost of funds for the bank, by considering the incremental cost of funds and not the total median cost of the funds and the loan tenor that affects the associated risks. The basic idea behind the MCLR regime is to provide banks with a uniform benchmark lending rate for different tenors that can be reset every month.

Before MCLR, banks were using several methods to calculate the base rate and the uniformity was missing. Henceforth, the system of base rate (that is connected to a cost of funds of the bank) did not succeed in attaining the objective of transparency. This happened owing to the regular claims by the banks that in spite of policy cuts given out by the RBI, their cost of funds has not reduced, and hence they were unable to roll out the revised interest rates to borrowers. And these benchmarks varied from bank to bank and from time to time.

With MCLR, RBI has standardized the benchmark rates across all tenors and hence has provided a uniform interest rate structure, which will help better the credit pricing process. Thus, the odds are not completely stacked against the borrower who enjoys more certainty and transparency.