Investment word of the day: As a personal loan or home loan borrower or as an investor planning to put money into the business, you will be curious to know certain key metrics that may impact the cost of borrowing. The Reserve Bank of India (RBI) has introduced certain metrics to understand the cost of borrowing conveniently for both borrowers and investors while aiming to bring transparency to the Indian banking system. The marginal cost of funds-based lending rate (MCLR) is one such measure introduced by the RBI.
What is MCLR?
The marginal cost of funds-based lending rate (MCLR) is the minimum rate at which banks are not allowed to lend. It sets the floor for interest rates charged by banks on loans. Hence, when the MCLR increases, interest rates on loans increase, and vice versa.
The RBI introduced MCLR on April 1, 2016, to set interest rates on bank loans. It replaced the base rate system to set lending rates for commercial banks. The base rate system was calculated using the average cost of funds while MCLR takes into account marginal costs.
How is MCLR calculated?
MCLR is calculated by adding the marginal cost of funds, operating costs, tenor premium, and negative carry on the CRR.
Marginal cost of funding: It is the cost of funds for the bank, such as the cost of deposits, borrowings, and other sources of funding.
Operating costs: The day-to-day expenses incurred by the bank, such as salaries, rent, and other operational costs.
Tenor premium: The additional interest rate charged by banks for loans with longer maturities.
Negative carry on the CRR: It is the cost of keeping funds as Cash Reserve Ratio (CRR) with the central bank.
Why is MCLR important?
MCLR has a direct impact on lending and investment. It directly relates to the pricing of loans, which is essential for people seeking home loans, personal loans, businesses looking to expand, and even investors who study market trends.
What does MCLR mean for borrowers?
“In the case of borrowing, MCLR guarantees that lending rates are properly disclosed and have a direct relationship with the rate of inflation. Compared to the previous base rate system, the MCLR is much more advanced, as it responds to changes in repo rate, as well as other banks’ costs of funds,” according to Siddharth Maurya, Founder & Managing Director, Vibhavangal Anukulakara Private Limited.
“Borrowers stand to gain because the increase of policy rates made available by the RBI allows them to benefit from low-interest rates. But borrowers possessing floating interest rate loans should pay particular attention to MCLR changes, as periodic resets affect their EMIs,” he added.
What does MCLR mean for investors?
For investors, MCLR also has a secondary effect on different financial tools. Generally, a diminutive MCLR provides an indication of an easing monetary approach, resulting in lowered lending rates, much more spending, as well as an increase in economic growth,” Maurya said.
However, it must be noted that a high MCLR will mean less availability of cash impacting sectors dependent on borrowings. Additionally, changes in MCLR will affect bonds because of lending rates, which in turn determine bond yields and returns.
Both investors and borrowers must consider MCLR before making financial decisions. Borrowers must take into account how changes would affect their loan responsibilities, and investors can use MCLR to determine the state of the economy and the sector’s performance.
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