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Marginal Cost of Funds based Lending Rate – MCLR

Marginal Cost of Funds based Lending Rate
Marginal Cost of Funds based Lending Rate

The final guidelines on Marginal Cost of Funds based Lending Rate is released by the RBI on Dec 17, 2015. The Marginal Cost of Funds based Lending Rate will be implemented w.e.f April 01, 2016. There was strong opposition from banks to implement Marginal Cost of Funds based Lending Rate. The objective of RBI is to pass the benefit of REPO Rate cut to borrowers. As i mentioned in my other posts that in last one year, RBI has cut REPO Rate by 125 basis point. On the other hand, an average base rate cut by banks is only 70 basis point. Technically, the Repo rate cut is not fully transmitted to borrowers. Before concluding this, it is imp to understand whether the increase in REPO Rate was fully transmitted to borrowers. The answer is NO. In short, Base Rate was not increased in the proportion of the increase in REPO Rate. Therefore, the cut in REPO Rate is also not fully transmitted. It is because of the way average cost of funds is calculated under Base Rate. Exactly this was the counter argument of the banks against Marginal Cost of Funds based Lending Rate. The base rate is linked to the average cost of funds for the banks. Therefore, REPO Rate cut or increase cannot be fully transmitted.

In this post, i will share whether MCLR is beneficial for a borrower or not. I will not share how it will be implemented. You must have already read it in the newspapers. On a lighter note, All the copycat bloggers will share with you :). As a borrower or investor, you are more interested to know how it will impact you. We will discuss how Marginal Cost of Funds based Lending Rate will change the landscape of Home Loan. I will share under what circumstances, it is beneficial to borrowers.

What is Marginal Cost of Funds?

The Marginal cost of funds is also known as the Incremental cost of funds. Let us understand with a simple example. Assuming i am a lender. I borrow at lower cost and lend at a higher cost. In layman terms, the net of lending cost minus borrowing cost after adjusting the cost of operation is my net profit. Now i will borrow from multiple lenders at the different interest rates. Similarly, i will lend at different interest rates to borrowers. It is quite a complicated situation. Assuming i keep a net profit margin of 1%. In banking terms, it is called markup or spread over base rate. Let say today my borrowing cost including a profit margin of 1% is 9%. In future it is 8.5% (Scenario A) & 7.75% (Scenario B) respectively. Under base rate calculation of the average cost of funds, i will lend in future at 8.75% (Scenario A) &  8.25% (Scenario B) respectively. 8.75% is average of 9% and 8.5% whereas 8.25% is the average of 8.75% and 7.75%. In short, under base rate Scenario A interest rate will be 8.75%, and Scenario B will be 8.25%. Therefore, under base rate, the benefit of a rate cut is not fully transmitted to the borrower.

Let see how it will work under Marginal Cost of Funds based Lending Rate. In this case, the incremental cost of funds will be taken as benchmark or lending rate. Therefore, if, under scenario A, i am borrowing at 8.5% then i will lend only at 8.5%. Similarly in scenario B, i will lend at 7.75%. In short, if my borrowing cost reduced, i will pass 100% benefit to my borrowers. In other words, under Marginal Cost of Funds based Lending Rate, Scenario A and B interest rate will be 8.5% and 7.75% respectively. Therefore, under Marginal Cost of Funds based Lending Rate the benefit of a rate cut is fully transmitted to the borrower.

Now compare Scenario A and Scenario B under Base Rate and Marginal Cost of Funds based Lending Rate. In scenario A, the Base Rate interest rate is 8.75% whereas MCLR interest rate is 8.5%. Wow, Borrower will save 0.25% under MCLR. Similarly, in Scenario B under base rate interest rate is 8.25% and MCLR is 7.75%. It’s excellent, saving of 0.5% in interest rate under MCLR. The Picture so far looks great. The conclusion is Marginal Cost of Funds based Lending Rate is in the BEST interests of the borrower. As a borrower, i should grab it without a second thought. But Hold ON, before you celebrate, please check next section.

Is Marginal Cost of Funds based Lending Rate beneficial?

Let’s flip the above example. The example mentioned above is for a situation when interest rates are decreasing. Let’s check another example when interest rate or REPO Rate is increasing. In this case, my current cost of borrowing including profit is same 9%. The interest rates increased, and my cost of borrowing in future is 9.5% (Scenario A) and 10.25% (Scenario B). In all fairness, i have kept the margin of 0.5% in Scenario A and 1.25% in Scenario B for both increase and decrease in Interest Rate. In base rate, i will lend at 9.25% in Scenario A and 9.75% in Scenario B.

Let’s check under Marginal Cost of Funds based Lending Rate. In MCLR, under scenario A, i will lend at 9.5%, and Scenario B lending rate will be 10.25%. Compared to the base rate, in the case of increasing interest rate under MCLR, i will pay 0.25% more in Scenario A and 0.5% more in Scenario B. Now, the WOW factor is gone in case of increasing interest rates. As per my analysis, Marginal Cost of Funds based Lending Rate is more beneficial during decreasing interest rate. On the other hand, Base Rate is more beneficial in case of increasing interest rate.

What to do next?

I received a lot of emails from my readers on Marginal Cost of Funds based Lending Rate. I have a lot to share on this topic. This post is first in series. In this post, i tried to answer most common query whether Marginal Cost of Funds based Lending Rate will be beneficial or not. Therefore, i already answered that Marginal Cost of Funds based Lending Rate is beneficial only in declining interest rate. Now as an existing borrower or new borrower you must be wondering what to do next. I have a different set of advice for both of them. Though we will be in a better position to take a call 2-3 weeks before implementation of Marginal Cost of Funds based Lending Rate.

(a) New Borrowers: In my opinion, you should avail Home Loans on or before March 31, 2016. In short, before Marginal Cost of Funds based Lending Rate kick in you can avail Home Loan linked to base rate. The interest rates are not expected to fall further because of increasing inflation. Once your loan is linked to Base Rate, you will always have the option to shift to Marginal Cost of Funds based Lending Rate. On the other hand, once you opt for Marginal Cost of Funds based Lending Rate, you cannot shift to Base Rate. You should borrow from Market leaders like SBI or ICICI Bank for lowest interest rate due to operational efficiencies.

(b) Existing Borrowers: Anyways nothing can be done till Mar 31, 2016. Therefore, don’t lose your sleep over Marginal Cost of Funds based Lending Rate. As i shared that in the case of an increase in interest rates, you will be benefitted through Base Rate compared to MCLR. You can always migrate to Marginal Cost of Funds based Lending Rate in future once the picture is clear.

At the macro level, a borrower should keep a close eye on interest rate movement and then decide accordingly. All the real estate experts and analysts are gung ho about Marginal Cost of Funds based Lending Rate without proper analysis. As i always say that life is zero sum game. The Profit and Loss are balanced equally. On a standalone basis, Banks may lose when interest rates will drop but will gain when it increase. As a banker i should be HAPPY as in last ten years, for the majority of the period interest rates were on increasing trend :).

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Umar Mohammad
Umar Mohammad
8 years ago

Hi Nitin Sir,
let me start with thanking you for all the valuable post and knowledge shared.( Request you to add the date of Post in beginning, so new user can understand opinions based upon market)

I need to get a loan of 35l by 15th April 2016, for which i have reached to SBI and HDFC.
As per insistence of Builder i was planning to get the disbursement by the end of March.

Post reading this post regarding MCLR, i am confused whether i should go for before or after 1st March?

In a reply to a query in “Floating Home Loan – BPLR or RPLR Vs Base Rate” posted below,
I read u suggesting to wait till 1st April because of speculations. and here you are asking for to get it done before 31st march.

Query from other post :”1. I suggest to wait till April’16 i.e. for MCLR implementation. Interest rates may decrease further and then you can pay conversion fees to take advantage of lower interest rates.”

My Query: Please suggest, as i am stuck in real time scenario :)

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Umar Mohammad

The suggestion on this post is for new home loans whereas the query posted by you from the post Floating Home Loan – BPLR or RPLR Vs Base Rate is for existing home loan. Hope it clarifies.

Currently, all the posts except in “Stocks” section are updated on regularly basis and are evergreen in nature. You may check RSS feed of the blog for published date.

Ramgopal Rajagopalan
Ramgopal Rajagopalan
8 years ago

Hi Nitin,

1. Do u have an idea on what are the banks uses Marginal CoF to calculate their base rate while most of the banks appears to use Average CoF to arrive at their base rate ??

2. With the base rate expected to be the lowest below which a bank cannot lend, how would they deal the scenario where MCLR is lower than base rate ?

3. With base rate regime, the markup is currently as low as 0.2%
will MCLR based home loans also offer a similar competitive spread ?

-Tks.

Nitin Bhatia
Nitin Bhatia
8 years ago

1. From 1st April, 2016 all banks will use Marginal CoF to calculate MCLR. Base Rate is replaced by MCLR.
2. For new borrowers, the interest rate will be linked to MCLR.
3. Now you cannot avail Home Loan linked to Base Rate. SBI and ICICI bank has set one year MCLR as benchmark for home loan interest rates. For ICICI Bank one-year MCLR is 9.20% and new markup us 0.25% therefore home loan interest rate is 9.45%

Amol
Amol
8 years ago
Reply to  Nitin Bhatia

Hi Nitin,
Whats the calculation for customers who Home loan are still tied to base rate, when Banks decide to pass on 25bps cut by RBI on April 5?

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Amol

As i explained that under base rate, it will take time to pass the benefit of rate cut. Therefore you should wait but it will definitely happen.

Amol
Amol
8 years ago

on April 1, MCLR is announced and April 5 RBI cut IR by 25 bps. Even though Banks may not be in a rush to cut this additional 25bps. but lets say eventually in 3-4 months Bank pass on this 25bps cut, would they decrease both MCLR and Base rate too? Whats the calculation for customers who Home loan are still tied to base rate?

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Amol

The MCLR rate cut will be sooner compared to base rate. Both will decrease.

Dipak
Dipak
8 years ago

Dear Sir,

My current outstanding loan is Rs 3143968 and current ROI is 11.45 from LIC. I am looking to switch my loan from LIC to SBI with current ROI is 9.50 for Women. As you said there is further reduction of rate in coming month so should i wait for some more months and pay some conversion fees Rs 1150 to LIC to reduce loan interest to 10.20. please suggest.

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Dipak

You may transfer to SBI immediately.

Rohit Rohra
Rohit Rohra
8 years ago

Dear sir,

I am taking home loan from Sbi, it’s almost sanctioned. Just want to know are there any chances that Sbi will announce new Mclr rates per latest repo rate cut of 25 bps within day or two

Thanks

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Rohit Rohra

It cannot be predicted.

Mudit Gupta
Mudit Gupta
8 years ago

Hi Nitin,
I have an outstanding principal balance of 24 Lacs for a house loan from HDFC. My current ROI is 9.65% with an EMI/month of Rs. 26,117 for a tenure of 183 months. As seen the recent cut in REPO rates, currently SBI is offering 9.45% (Maxgain) on Transfer of Loan from HDFC to SBI. I also checked with HDFC where I have an option of rate conversion to 9.40% by paying Rs. 5725 (conversion fee+service tax). My current BPLR is 16.30% that means current spread is 6.65% where as after rate conversion the spread will change to 6.90%.
For a longer period of time what should be more beneficial as every year I might need to pay the conversion fee for rate conversions with HDFC reset period of 3 months. Should I move to SBI or stick to HDFC ? I will be happy to seen your details analysis on this.

Nitin Bhatia
Nitin Bhatia
8 years ago
Reply to  Mudit Gupta

In my opinion you should accept conversion offer of HDFC. For detailed explanation you may opt for phone consultation.

Patil
Patil
7 years ago

Hi Nitin
i have home load with HDFC and my home load interest rate is 9.5% with BPLR is 16.30% and spread is 6.80%. Ohter bank are offering 9.4%. Also HDFC offer me 9.4% by paying Rs. 5625 as conversion fee. They told the will increase my speared to 6.9% So i will go with other bank or will i pay conversion fee and continue with HDFC.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Patil

I suggest you to wait till Oct’16.

Tom
Tom
7 years ago

Mr Nitin,Once we opt for change over to MCLR from Base Rate, can we reverse it later ?

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Tom

Good to know you did extensive research and your understanding is correct.

As per my analysis, Marginal Cost of Funds based Lending Rate is more beneficial during decreasing interest rate. On the other hand, Base Rate is more beneficial in case of increasing interest rate. If you switch to MCLR, you will not get any immediate benefit. In my opinion, you should continue with Base Rate.

Tom
Tom
7 years ago
Reply to  Nitin Bhatia

Thanks Mr Nitin, I completed the extensive research through your blog only.I am a simple layman and it shows that your writings were very laymen- friendly ! Keep it up !

sreenath thotamsetty
sreenath thotamsetty
7 years ago

Hi Nitin,

I want to understand whether switching to MCLR will make sense in below scenario.

Currently my home loan with ICICI is tied with base rate+variance (9.3+.15) as 9.45, i could see ICICI bank is announced MCLR as 9.05%, does it have any variance also ?
Do you suggest to switch from Base rate to MCLR for me?

Nitin Bhatia
Nitin Bhatia
7 years ago

There will not be any immediate benefit as your interest rate will remain same. ICICI bank will offer 9.05% + 0.40% = 9.45%. As i shared in my post that as per my analysis, Marginal Cost of Funds based Lending Rate is more beneficial during decreasing interest rate. On the other hand, Base Rate is more beneficial in case of increasing interest rate.

Currently, interest rates have almost bottomed out. In my opinion, you should continue with Base Rate.

sreenath thotamsetty
sreenath thotamsetty
7 years ago
Reply to  Nitin Bhatia

Thanks Nitin.

Even i thought to continue in the same Base rate as there is no much differences.
Your articles are pretty good and easy to understand

Tapan
Tapan
7 years ago

Hi Nitin,

I am looking for a home loan from SBI or Axis bank. SBI is offering 9.05+0.30% = 9.35% for Max gain n vs Axis rate of 9.25% + 0.15% for similar OD product. Which one would you recommend? Thanks.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Tapan

I will prefer SBI maxgain

Purvi Zala
Purvi Zala
7 years ago

Dear Nitin,
We started our Home Loan with BOB at 9.65% base rate.Since then RBI introduced MCLR in April and Repo rate has been reduced in April and October -16.Should I switch to MCLR or be on base rate model only(que.1)
I talked to one of the BOB credit manager he said we will be switched over to MCLR without our choice in near future even if we don’t want to,Is that so?(que 2)
I have been a reader of your web site since I wanted to buy a new flat and your blogs are very layman friendly and educative in nature thanks for creating wonderful site.
Also can you elaborate with an example how interest will be calculated if I want opt for home loan on MCLR basis with current BOB MCLR rate now.( because I want to understand concept of strategic premium they accrue).(que.3)
Thanks.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Purvi Zala

1. In my opinion, you should continue with Base Rate. As per my analysis, Marginal Cost of Funds based Lending Rate is more beneficial during decreasing interest rate. On the other hand, Base Rate is more beneficial in case of increasing interest rate.

The interest rates have almost bottomed out.

2. BOB credit manager is misleading you. It is not correct. The banks are anticipating increase in interest rate because of inflation thus financially it will be beneficial for banks if customer move to MCLR. The MCLR will increase more compared to base rate in case interest rate start moving northwards. You can continue with base rate for entire home loan tenure.

3. Your interest rate will remain same. There is no immediate benefit to shift to MCLR from Base Rate.

Purvi Zala
Purvi Zala
7 years ago
Reply to  Nitin Bhatia

Thanks again

Purvi Zala
Purvi Zala
7 years ago

Dear Nitin,
I would also like to know that if current rate of interest with BOB is 9.65% and SBI is offereing at 9.3% then should we switch the loan over to SBI, If yes then what are the pros and cons of that in terms of additional expenditure or documentation.We will complete one year with this bank in next February.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Purvi Zala

Firstly, you should check cost of transfer with SBI. It is different in each state and as currently festive season is going on therefore SBI might waive of processing fees or some other charges. After estimating the cost of transfer you need to check how long will you take to recover the cost of transfer and subsequently net benefit i.e. interest savings. Based on these calculations you may decide to transfer or not.

Purvi Zala
Purvi Zala
7 years ago
Reply to  Nitin Bhatia

Dear Nitin,
Thank you very much for prompt and accurate reply.

Sridhar
Sridhar
7 years ago

Sir, I have applied for home loan. It is expected that interest rate will be reduced by RBI in next monetary policy. Hence, is it advisable to take cheque after the RBI policy announcement. Further, I heard that the bank will reset interest rates before one year for existing borrower under mclr. In this case if i accept cheque now, my rate of interest on home loan will be reset only after one year. I will be getting sanction letter in few days.

Nitin Bhatia
Nitin Bhatia
7 years ago
Reply to  Sridhar

Once you receive sanction letter, your home loan will be governed by the terms and conditions as applicable and mentioned in the sanction letter. Therefore, you can take disbursement any day after that and subsequent events like RBI’s decision etc will not impact you. As you rightly mentioned that interest rate reset under MCLR is 1 year.

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