What does Marginal Cost of Funds Based Lending Rate (MCLR) mean, and how does it affect the interest rates charged on loans?

Marginal Cost of Funds Based Lending Rate (MCLR) is the minimum rate of interest below which banks cannot lend, introduced by the Reserve Bank of India to ensure efficient monetary policy transmission.

MCLR reflects banks' marginal cost of funds and directly influences business loan interest rates.

MCLR comprises four components: marginal cost of funds, negative carry on CRR, operating costs, and tenure premium. Banks calculate MCLR monthly based on their funding costs, including deposits, borrowings, and return on net worth.

Impact on business loans:

• All floating rate loans are priced above applicable MCLR
• Interest rate changes follow MCLR revisions on reset dates
• Lower MCLR enables banks to offer competitive loan rates
• Higher MCLR increases borrowing costs for businesses

MCLR varies by tenure, with overnight, one-month, three-month, six-month, and one-year rates. Most business loans are linked to one-year MCLR plus credit spread based on borrower risk assessment.

When RBI reduces policy rates, banks' funding costs decrease, leading to lower MCLR and reduced loan interest rates. Conversely, rate increases result in higher MCLR and increased borrowing costs.

Borrowers benefit from MCLR-linked loans during falling rate cycles but face higher costs during rising rate environments. Reset frequency determines how quickly interest rate changes impact existing loans.

For business planning, monitor MCLR trends and RBI monetary policy signals. Consider fixed-rate options during rising rate cycles or floating rates when rates are expected to decline. Negotiate credit spreads and reset frequencies to optimise interest costs based on business cash flow patterns and market expectations.