Difference Between MCLR Rate and Base Rate You Should Know

With the Reserve Bank of India changing its policy, knowing the difference between base rate and MCLR is important when you are planning to take a loan. Since July 2010, the base rate structure has been in use. As per its provisions, banks had to update the rates for loans and deposits every quarter. 

However, after five years, the RBI’s new rate system has replaced it. The new system ensures better transparency, as financial institutions cannot change the interest beyond a margin. Therefore, it is crucial to understand how the new lending rates are a step up when compared to the older rates and how they make your loan affordable. 

Guide to the Base Rate

This is the minimum interest rate set by the RBI, below which financial institutions cannot charge interest on the loan. This sets a benchmark to ensure transparency, fairness and consistency among lenders. 

It also directly affects the economy, as it concerns borrowing activities. For example, if the RBI increases the base rate, loans become expensive for individuals and businesses. This way, people avoid borrowing due to the high interest rate. Alternatively, if it’s reduced, it stimulates economic activity as the loans become cheaper. 

Meaning of MCLR

Marginal Cost of Funds Based Lending Rate is the new benchmark for determining the minimum interest rate for financial institutions in India. It was introduced on 1st April 2016 to replace the base rate.  

Difference Between Base Rate and MCLR

Both these rates work on the same principle as they help calculate the lowest interest for loans. Previously, some banks were using the average cost of funds while others relied on the marginal cost of funds. This created an unsystematic standard and nullified the role of repo rates. 

Therefore, the RBI decided on a new system which uses the cost of all the banks’ new loans and the cost of new deposits. As such, the difference arises due to the factors used in calculating both these rates. 

Also Read: Personal Loan RBI Guidelines

Base Rate and MCLR: Affecting Factors

Know all these factors to better understand their differences and know how lenders calculate them. 

Base Rate	MCLR
Interest rate depends on the average cost of funds	Interest rate depends on the marginal cost of funds
Expenses of operating and maintaining the cash reserve ratio determine the rate	Operating costs and cost of maintaining the cash reserve determine the rate
Independent of repo rates	Depends on the repo rates
Changes every quarter	Depends on the loan tenure

Can you switch to the MCLR rate?

If your loan was approved and disbursed before 1st April 2016, then you have the option to switch to MCLR. This rate automatically applies if you had a loan sanctioned after this date. However, you should compare if switching is a good option for your loan before requesting your lender. 

Since this rate depends on the repo rate decided by the RBI, your interest rate may go down. However, if RBI increases the repo rate, you may have to pay higher interest. Moreover, you cannot switch to the base rate once you’ve opted for the new rates. Analyse your current interest rates and the risks of higher rates to make a smart decision.

With these updates, loans become more affordable, allowing you to get competitive rates to make informed decisions. This way, you don’t have to worry about stable lending rates as Banks and NBFCs must follow the benchmark set by the RBI. 

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FAQs on Base Rate vs MCLR

How do I change my base rate to MCLR?

You can switch to MCLR by requesting your bank. Know that once you switch, you cannot return to the base rate. 

Is MCLR better than the base rate?

Yes, it has a lower rate despite the fact that they are based on similar principles. This is because it depends on the marginal or incremental cost of funds, while the base rate depends on the profit margin or return rate. 

How is MCLR calculated?

To calculate it, banks consider the following factors:

• Marginal cost of funds
• Operating costs
• Tenor premium
• Negative carry-on cash reserve ratio

Who decides the base rate?

Banks decide the base rates for the interest rate. However, it is influenced by the guidelines of the Reserve Bank of India. For this calculation, they determine many factors. So, even if it is the bank’s jurisdiction to set the base rate, it is based on a regulatory framework established by the central bank.