Importance of MCLR in Mortgage & Home Loan Industry
MCRL (Marginal Cost Of Funds Based Lending Rate) got introduced in financial system of India in 2016 by the Reserve Bank Of India. It was a replacement to the earlier base rate system which was introduced in 2010.
It is the benchmark interest rate for the banks below which the bank cannot offer to lend funds/loan to the borrower. It is directly connected with the REPO rate of RBI. REPO rate means a rate at which RBI provides funds to the banks. Any changes in the REPO rates will also affect MCLR rates of the banks.
The MCLR rates differ from bank to banks. It is also different for different loan tenures. The banks have set 5 MCLR rates which are overnight, one month, 3 months, 6 months & 1 year.
For deriving MCLR – the 4 most important factors which are considered are:
1) Marginal Cost Fund 2) Negative Carry on Cash Reserve Ratio
3) Operative Costs of Banks 4) Tenure Premium.
How MCLR Does differs from Base Rate:
1.Calculation of Base Rate is based on the cost of funds, minimum rate of interest i.e. margin or profit, operating expenses and cost of maintain CRR.
2.MCLR is based on marginal cost of funds, tenure premium, operating expenses and cost of maintain CRR.
(CRR means percentage of total amount of cash, banks deposits in RBI as a safety & statutory measure (main purpose-so that banks do not run out of cash to meet the payment demands of their depositors). RBI does not pay any interest on such deposited cash amount.)
The main factor of difference between the both systems is the calculation of marginal cost under MCLR. Marginal cost is charged on the basis of interest rates for various types of deposits, borrowings and return on net-worth.
The formula prescribed by RBI for calculation of marginal cost of funds = marginal borrowings cost X 92% + return on the net worth X 8%.
The Main PURPOSE why MCLR was introduced:
The base rate is the minimum rate of interest that is fixed by all banks. The base rate sought to ensure that banks do not lend to customers below a certain benchmark. The RBI also wanted to make sure that any changes in the interest rate policy were handed down to borrower. But the transmission of the interest rates was not effective in the base rate system. Even if the RBI cut the repo rate banks did not always follow the suit. They did not pass in full benefits to the customers or there was a big time delay. Therefore, the MCLR system was introduced.
The main purpose for its introduction can be summarized in two points:
1) Improving the transparency in the methodology followed by banks for determining the interest rates on advances.
2) Ensure availability of bank credit at interest rates which are fair to both the borrowers as well as the banks.
MCLR linked loans will be reset for maximum of 1 year. So a borrower/customer will have a new interest rate on his loan at a pre-decided time and for a maximum period of 1 year. For the home loan/mortgage loans banks either uses 6 months or 1 year MCLR as the benchmark rate.
Hence the final rate at which the borrower borrows consists of the MCLR + spread (decided on the credit risk + tenure).
A borrower who has borrowed the funds under base rate scheme is allowed to transfer his loan in MCLR as per the RBI guidelines. By paying a certain conversion cost as levied by the banks he can enjoy the benefits of MCLR. However, once he opts for MCLR switching back to base rate system is not allowed.
MCLR is Not Applicable to:
1) Loans covered by government schemes where banks have to charge interest rates as per the scheme are exempted from being linked to MCLR.
2) Since MCLR is applicable only to the banks, loans that are taken from finance companies / financial institutions do not fall under this system.