MCLR – Marginal Cost of Funds Based Lending Rate

The MCLR methodology was introduced by RBI for fixing interest rates from 1 April, 2016 replacing the base rate system that was introduced in the year 2010.

The marginal cost of funds based lending rate is the minimum interest rate of a bank below which it cannot lend, except in some cases allowed by the RBI. It is a tenor-linked internal benchmark, which means the rate is determined internally by the bank depending on the period left for the repayment of a loan.

Banks have to face a strict regulatory action if they lend below this rate and have to review and publish their MCLR of different maturities every month — overnight, one-month, three month, six-month and one-year.


The MCLR came into effect to fulfill the following objectives :-

  • To enhance transmission of RBI policy rates into the country’s banking system.
  • To ensure fairness in credit interest rates for both banks and borrowers.
  • To pass the benefits of reduced interest rates to customers as early as possible.
  • To improve transparency in the system utilized by banks to fix interest rates on loans.


The formula prescribed by the Reserve Bank of India for calculation of MCLR is given below:

Marginal cost of funds = Marginal borrowing cost x 92% + return on the net worth x 8%

MCLR is closely linked to the actual deposit rates and is calculated based on four components: the marginal cost of funds, negative carry on account of cash reserve ratio, operating costs and tenor premium.

Banks must also maintain a cash reserve ratio of 4%. On this deposit, no interest is earned by the bank. Under MCLR, banks can avail some allowance called Negative Carry on CRR. Also, the operating costs must be considered and taken care of. There are several expenses of a bank that includes raising funds, opening branches, paying salary to its employees etc which are not charged to customers.


Thus, the MCLR system aims to improve the faith of the individual borrowers and business in the banking sector & also helps the country’s financial regulatory body to take more effective monetary policy measures by enhancing the faster and effective transmission of policy rates.

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