MCLR

The Marginal Cost of Funds-based Lending Rate was introduced by the RBI to address a persistent criticism of the earlier base rate system: that banks were slow to pass on RBI rate cuts to borrowers. Under the base rate regime, banks calculated their cost of funds using average historical deposit rates, which moved slowly. MCLR shifted the calculation to the marginal cost — the rate a bank would need to pay today to raise one additional rupee of funds — making the benchmark more sensitive to current market conditions.

The MCLR is computed for multiple tenors (overnight, one month, three months, six months, one year, and longer), with the one-year MCLR being the most widely used for retail loans. The computation covers four components: marginal cost of funds (weighted average of deposits and borrowings at current rates, given 92% weight), negative carry on CRR (the opportunity cost of holding zero-interest CRR balances), operating expenses, and tenure premium. Banks reset their MCLR at least once a month and review it on the applicable reset date for each loan.

Despite being more responsive than the base rate, the MCLR system still drew criticism for incomplete and delayed transmission. The RBI found that between January 2015 and October 2019, the repo rate was cut by 275 basis points, but median MCLR-linked lending rates fell by only around 100 basis points. This gap reflected banks' reluctance to reduce deposit rates quickly (to retain depositors) and their own balance-sheet constraints. The incomplete transmission prompted the RBI to mandate external benchmark-linked rates for new floating-rate retail and MSME loans from October 2019.

Existing MCLR-linked loans were grandfathered — borrowers with outstanding home or auto loans linked to MCLR continue to see resets based on their bank's published MCLR at the applicable reset interval. This dual-track system — MCLR for legacy loans and external benchmarks for new loans — means that millions of Indian borrowers still watch their banks' MCLR announcements to anticipate EMI changes.

For investors analysing banks, MCLR movements reflect shifts in a bank's funding cost and competitive pricing strategy. A bank that holds its MCLR steady while peers cut may be defending margins but risking loan growth as borrowers switch. Conversely, an aggressive MCLR cut may signal competitive pressure or a deliberate strategy to grow the retail loan book even at slightly compressed margins.