Marginal Cost of Funds-based Lending Rate (MCLR)

The primary purpose of MCLR (Marginal Cost of Funds based Lending Rate) is to enhance transparency and ensure a fair transmission of changes in the policy rates set by the central bank (like the Reserve Bank of India in the case of India) to the lending rates offered by commercial banks.

MCLR (Marginal Cost of Funds based Lending Rate) is calculated using the following components and methodology:

1. Marginal Cost of Funds (MCoF): It includes various factors such as the repo rate (the rate at which the central bank lends money to commercial banks), marginal cost of borrowings, return on net worth, and operating costs.
2. Tenor Premium: Banks add a premium to the MCoF based on the time period of the loan (tenor). Longer-term loans tend to have a higher tenor premium.
3. Negative Carry on Cash Reserve Ratio (CRR): Banks are required to maintain a certain portion of their deposits as reserves with the central bank (CRR). The cost of holding these reserves, known as the negative carry on CRR, might also be factored into the MCLR calculation.

The formula for calculating MCLR is: $\text{MCLR}=\text{MCoF}+\text{Marginal Cost of Funds x Interest Rate Reset Frequency}+\text{Tenor Premium}+\text{Operating Expenses}+\text{Negative Carry on CRR}$ Banks are required to review and publish their MCLR rates monthly across various tenors (overnight, one month, three months, six months, one year, etc.) to which they lend. The rates are generally benchmarked against the repo rate or other short-term interest rates, ensuring that changes in these benchmark rates are swiftly transmitted to borrowers’ loan rates.