The interest rate on a business loan is not always determined in a vacuum. Some bank loans have lending rates tied to a benchmark, which is an indicator of the cost of funds for the bank. The MCLR was introduced by the Reserve Bank of India in 2016 to bring greater transparency to banks’ rate-setting mechanism and to improve the transmission of changes in policy rates.
When dealing with floating-rate loans, the MCLR benchmark can influence the rate charged to a borrower, depending on the type of loan and the applicable regulatory framework. It also helps explain why two loans from the same bank could have different interest rates depending on their benchmark, spread and other terms.
What is MCLR and What Does it Mean?
The MCLR stands for Marginal Cost of Funds Based Lending Rate. It is an internal benchmark used by banks to determine the minimum lending rate for specific types of loans. The benchmark is based on the bank’s marginal cost of raising funds and varies with the loan’s tenor.
The final interest rate each borrower pays differs from the MCLR rate. The applicable spread is added to the relevant MCLR to determine the actual lending rate for loans linked to MCLR. Every month, banks review and publish MCLR rates for various maturities.
MCLR also differs from an external benchmark. An external benchmark is a market-based reference rate outside the bank’s control, while MCLR is calculated internally by the bank using prescribed components. This distinction is particularly important for MSME borrowers because new floating-rate loans to retail and MSME borrowers are subject to the external benchmark framework.
How is MCLR Calculated?
Banks calculate MCLR using specific cost and operational components rather than relying on a single interest-rate figure. Under the applicable framework, the calculation includes the following:
| Component | What it Represents |
| Marginal Cost of Funds | The additional cost incurred by the bank to raise funds |
| Negative Carry on CRR | The cost arising because funds maintained as CRR do not earn a return |
| Operating Costs | Costs associated with providing and servicing loans |
| Tenor Premium | An additional component linked to the maturity period of the loan |
The broad structure can therefore be understood as:
MCLR = Marginal Cost of Funds + Negative Carry on CRR + Operating Costs + Tenor Premium
How Does MCLR Affect Business Loan Interest Rates?
The MCLR rate can influence the interest charged on loans that are linked to it. When the applicable MCLR changes, the interest rate on a floating-rate loan may also change on its scheduled reset date. This can affect the EMI or the overall interest cost, depending on the loan terms.
The impact is not the same for every borrower. The final lending rate may include a spread over the applicable MCLR, and the reset frequency depends on the loan terms. This is why borrowers should check both the benchmark and the spread rather than the MCLR figure alone.
What is the Difference Between MCLR and an External Benchmark?
MCLR is an internal benchmark calculated by a bank using its own funding and operating costs. An external benchmark, on the other hand, is a reference rate that is not determined by the individual bank.
For eligible retail and MSME borrowers, new floating-rate loans are linked to an external benchmark under the RBI’s lending-rate framework. MCLR therefore does not apply to every new business loan. The applicable benchmark depends on the type of loan, borrower category and date of sanction or renewal.
| Basis | MCLR | External Benchmark |
| Nature | Internal bank benchmark | Rate outside the individual bank |
| Determination | Based on prescribed bank-level cost components | Linked to an eligible external reference rate |
| Review | Published by banks for different tenors | Depends on the applicable benchmark |
| Application | Applies to specified loans | Applies to loans covered under the external benchmark framework |
What is the Difference Between MCLR and Bank Loan Interest Rates?
MCLR and the interest rate charged to a borrower are not necessarily the same. MCLR acts as the benchmark for loans that are linked to it, while the final lending rate can include a spread determined by the bank.
For example, if a loan is linked to a particular MCLR and the bank applies an additional spread, the borrower’s interest rate will be higher than the benchmark itself. The applicable spread and other loan terms should therefore be checked before comparing two borrowing options.
What are the Benefits of MCLR for Borrowers?
MCLR was introduced to make bank lending rates more responsive to changes in the cost of funds and improve transparency in the rate-setting process. For borrowers with MCLR-linked loans, changes in the benchmark can flow through to the lending rate at the applicable reset date.
It also gives borrowers a reference point for understanding how their loan rate is determined. However, the actual benefit depends on the loan category, the applicable spread, the reset period, and other terms agreed with the lender.
How Can Businesses Manage Changes in Loan Interest Rates?
Businesses with floating-rate loans should keep track of the applicable benchmark and the loan’s reset schedule. A change in the benchmark can affect borrowing costs, so understanding when the rate may be revised helps businesses plan their cash flows more effectively.
It is also useful to review the loan agreement and compare the applicable interest rate with other available financing options before taking additional debt. Borrowing an amount that matches the business’s repayment capacity can help prevent changes in interest costs from putting unnecessary pressure on working capital.
Conclusion
Understanding what is MCLR can help businesses make sense of how benchmark-linked lending rates work. The MCLR rate is an internal benchmark used for specified categories of loans, and the final interest rate may include a spread over the applicable MCLR. Since not every new MSME loan is linked to MCLR, borrowers should check which benchmark applies to their specific loan.
At Lendingkart, we understand that choosing suitable business finance involves looking beyond the headline interest rate. Eligible MSMEs can explore business financing options based on their requirements and repayment capacity, carefully comparing the applicable loan terms before making a borrowing decision.
FAQs
What is the MCLR full form in banking?
The MCLR full form in banking is Marginal Cost of Funds-Based Lending Rate.
What is MCLR?
MCLR is an internal benchmark used by banks to determine lending rates for specified categories of loans.
What does MCLR means for a business loan?
For an MCLR-linked floating-rate loan, a change in the applicable benchmark can affect the interest rate at the next reset.
How is MCLR calculated?
MCLR is calculated using components such as the marginal cost of funds, negative carry on the CRR, operating costs, and tenor premium.
Does MCLR apply to all MSME loans?
No. New floating-rate loans to eligible retail and MSME borrowers are generally linked to an external benchmark under the applicable RBI framework.
