Highlight: Learn what the MCLR rate is and how it affects different loans. Understand how changes in MCLR can influence your personal loan interest and EMIs.
The Marginal Cost of Funds based Lending Rate (MCLR) was introduced by the Reserve Bank of India (RBI) in April 2016 to replace the older base rate framework. Under MCLR, banks determine lending benchmarks by factoring in the repo rate and their cost of deposits. This approach requires commercial banks to set internal lending rates that reflect the marginal cost of raising funds, making rate-setting more responsive to market conditions.
Why MCLR was needed
Under the previous base rate system, banks were often slow to pass on RBI rate changes to borrowers. While the RBI adjusted policy rates, banks did not always move their lending rates in step, which reduced the transmission of monetary policy. MCLR was introduced to improve this transmission by linking lending rates more closely to each bank’s marginal cost of funds and risk profile for different customer segments.
Banks now maintain separate benchmark rates for various tenors, ranging from overnight or one-month to one-year. These short-tenor benchmarks serve as the basis for pricing loans of longer durations as well.
What is the MCLR rate?
MCLR is the minimum lending rate below which a bank generally cannot issue loans. “Marginal” refers to the additional cost or change in the bank’s funding cost. MCLR is updated periodically—commonly monthly—based on the repo rate, deposit rates and other borrowing costs. In most cases banks are not permitted to lend below the published MCLR, with a few specified exceptions.
Banks may lend below MCLR in limited circumstances, for example:
- Loans backed by deposits
- Loans extended to the bank’s own employees
Types of loans linked to MCLR
Following RBI guidelines, all floating-rate loans sanctioned on or after April 1, 2016, use MCLR as the reference for rate resets, including renewals. Existing floating-rate borrowers were given options to switch to MCLR-based pricing. Common floating-rate products tied to MCLR include home loans, corporate term loans and loans against property.
Banks may also link other floating-rate products—such as certain educational loans, auto loans and some personal loans—to MCLR. If your personal or auto loan carries a floating interest rate and is bank-originated, it is likely to be tied to the bank’s MCLR.
Does MCLR affect personal loans?
MCLR affects only floating-rate personal loans. Fixed-rate personal loans remain unaffected by MCLR movements. For variable-rate personal loans tied to MCLR, rate reductions can lower EMIs over time, making such loans more affordable when MCLR declines.
Components of the MCLR
MCLR is calculated from several components, including:
- The marginal cost of funds, which captures the cost of borrowings and return on net worth
- Operating costs incurred by the bank
- Negative carry on cash reserves kept with the RBI
- Tenor or risk premium charged for longer-tenure loans
Banks determine marginal cost using factors such as deposit rates (savings, current and term), borrowings across maturities, and the repo rate. In practice, roughly 92% of the MCLR is driven by marginal fund costs, repo and deposit rates, while return on net worth accounts for the remaining portion.
* 18% GST applies to banking services and products from 01 July 2017.
How MCLR affects bank loans
MCLR has several implications for borrowers and bank lending practices:
- Better rate transmission: Previously, banks tended to raise floating loan rates quickly when policy rates rose but were slower to reduce rates when policy rates fell. MCLR requires regular recalibration of lending rates in line with marginal cost conditions, improving pass-through of RBI rate moves.
- Controlled spread: Under MCLR, banks must declare the spread at the time of loan sanction. That spread generally cannot be increased during the loan tenure unless the borrower’s credit profile materially changes. This reduces arbitrary widening of spreads that previously raised borrower costs.
- Transparent pricing: MCLR enhances transparency by separating the bank’s benchmark cost from the spread charged to the borrower. Banks are required to publish MCLR rates for multiple tenors each month, which helps borrowers compare pricing.
- Stable bank margins: With MCLR, banks still earn margins through the spread, but the mechanism limits unexpected changes to that spread during the loan term and ensures regular rate resets—for example, at least annually for applicable products.
Exemptions from MCLR
MCLR rules apply only to banks and not to non-banking financial companies (NBFCs) or other financial institutions. Many NBFCs and housing finance firms follow their own benchmarks. Certain loan categories are also exempt from MCLR, including car loans, fixed-rate home loans and fixed-rate personal loans. Loans provided under central or state government schemes that carry a specified government-directed rate are likewise exempt.
Conclusion
Under the MCLR framework, banks generally cannot lend below their published MCLR for a given maturity. However, specific exemptions—such as loans to bank employees, certain government-subsidized schemes and some long-term fixed-rate arrangements—remain outside its scope. Overall, MCLR aims to make lending rates more responsive, transparent and fair for borrowers when market conditions change.