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When you take a floating-rate loan, the benchmark used by your bank can affect how your interest rate changes over time. Two important internal lending benchmarks used by Indian banks are the Base Rate and the Marginal Cost of Funds Based Lending Rate (MCLR). 

The Reserve Bank of India (RBI) introduced the Base Rate system on 1 July 2010 to replace the earlier Benchmark Prime Lending Rate (BPLR) system. Under this framework, banks were required to calculate their own Base Rate according to RBI guidelines and use it as a benchmark for lending. 

To improve transparency and make lending rates more responsive to changes in banks’ funding costs, the RBI introduced MCLR on 1 April 2016. 

Understanding the difference between Base Rate and MCLR can help you know how your loan interest rate is calculated and whether changing your loan benchmark may be beneficial. 

It is also important to note that since October 2019, many new floating-rate retail loans offered by banks have been linked to external benchmarks, such as the RBI repo rate. However, older loans may still be linked to the Base Rate or MCLR depending on when they were sanctioned and the applicable loan terms. 

What is Base Rate? 

The Base Rate is an internal benchmark lending rate calculated by individual banks according to RBI guidelines. 

It represents the minimum lending rate below which a bank generally could not lend, except in certain categories permitted under RBI regulations. 

The Base Rate system was introduced to improve transparency and consistency in how banks determined lending rates. There is no single Base Rate prescribed by the RBI for all banks. Instead, each bank determines its Base Rate based on its funding costs and other financial parameters within the RBI framework. 

Changes in the Base Rate may affect borrowers whose floating-rate loans are still linked to this benchmark. If the bank increases its Base Rate, the applicable loan interest rate may rise. Similarly, a reduction may result in a lower interest rate, depending on the loan terms. 

How is Base Rate Calculated? 

Banks calculate the Base Rate by considering several financial factors. These broadly include: 

• Average cost of funds: The cost incurred by the bank while raising money through deposits and other funding sources. 

• Minimum rate of return: The minimum return the bank expects on the capital deployed for lending. 

• Operating expenses: Administrative and operational costs incurred while providing banking and lending services. 

• Cost of maintaining CRR: Banks are required to maintain a portion of their deposits as Cash Reserve Ratio (CRR) with the RBI. The cost associated with maintaining this reserve is considered while determining the Base Rate. 

Banks are required to use a transparent and consistent methodology while determining their Base Rate and review the rate periodically. 

What is MCLR? 

MCLR, or Marginal Cost of Funds Based Lending Rate, is an internal lending benchmark introduced by the RBI with effect from 1 April 2016. 

It was introduced to address some of the limitations of the Base Rate system and improve the transmission of monetary policy changes to bank lending rates. 

MCLR places greater emphasis on the marginal or incremental cost of funds, which refers to the cost banks incur while raising fresh funds. 

Banks generally publish different MCLR rates for different tenures, such as: 

• Overnight 

• One month 

• Three months 

• Six months 

• One year 

The MCLR applicable to a loan depends on the benchmark selected by the bank for that particular product. 

How is MCLR Calculated? 

MCLR is primarily calculated using the following four components: 

1. Marginal Cost of Funds 

• This represents the cost of raising fresh or incremental funds. It considers factors such as the marginal cost of borrowings and the return expected on the bank’s net worth. 

2. Negative Carry on CRR 

• Banks are required to maintain a certain proportion of deposits as Cash Reserve Ratio with the RBI. Since these funds cannot be deployed for lending, the associated cost is considered while calculating MCLR. 

3. Operating Costs 

• These include operational and administrative expenses incurred by the bank in raising funds and providing loans. 

4. Tenor Premium 

• The cost and risk associated with lending generally increase with the tenure of the loan. Banks may therefore add a tenor premium depending on how long the funds are committed. 

These components together determine the MCLR applicable for different loan tenures. 

Difference Between Base Rate and MCLR 

Both Base Rate and MCLR are internal benchmark rates used by banks to determine lending rates. However, the key difference lies in how the cost of funds is calculated. 

Under the Base Rate framework, banks could consider average funding costs as part of their calculation. This meant that changes in the RBI’s monetary policy or market interest rates did not always translate quickly into changes in lending rates. 

MCLR places greater emphasis on the marginal cost of newly raised funds. As a result, changes in banks’ funding costs and monetary conditions can generally be reflected more efficiently in MCLR than under the older Base Rate framework. 

This was one of the primary reasons for shifting from Base Rate to MCLR – to improve the speed and effectiveness of monetary policy transmission. 

However, an MCLR-linked borrower may not see an immediate change in their interest rate whenever the MCLR changes. The applicable loan rate is generally revised on the loan’s specified reset date. 

Also Read: Personal Loan RBI Guidelines 

Base Rate vs MCLR: Key Differences 

Parameter	Base Rate	MCLR
Cost of funds	Primarily considers the broader or average cost of funds along with other factors	Focuses mainly on the marginal or incremental cost of funds
Key calculation factors	Cost of funds, minimum return, operating expenses and cost of maintaining regulatory reserves	Marginal cost of funds, negative carry on CRR, operating costs and tenor premium
Monetary policy transmission	Changes in policy rates may take longer to reflect in lending rates	Designed to transmit changes in funding costs and monetary conditions more effectively
Rate structure	Generally one Base Rate for a bank	Different MCLR rates are available for different tenures
Rate review	Reviewed periodically, generally at least once every quarter	Reviewed and published periodically for different maturity periods
Transparency in rate disclosure	Banks disclose their Base Rate, but calculation methodologies could vary	Uses a more standardised framework with tenor-wise benchmark rates
Impact on existing vs new borrowers	Older eligible loans may continue under the Base Rate framework	Loans sanctioned or migrated under the MCLR regime may be linked to an applicable MCLR and reset periodically

How to Switch from Base Rate to MCLR? 

If your existing loan is linked to the Base Rate, you may be able to request your bank to shift it to an MCLR-linked structure. 

Switching is not mandatory for eligible existing Base Rate borrowers. Before opting for a change, compare your existing loan terms with the terms available under the new benchmark. 

You can follow these steps: 

1. Check your current loan benchmark 

• Review your loan statement, sanction letter or loan agreement to confirm whether your loan is linked to the Base Rate. 

2. Check the applicable MCLR 

• Visit your bank’s official website or contact the lender to know the MCLR applicable to your loan type and tenure. 

3. Ask for the revised interest rate 

• Request the bank to provide the effective interest rate that would apply if you switch from Base Rate to MCLR. 

4. Compare the effective loan rates 

• Do not compare only the Base Rate and MCLR percentages. Consider the final lending rate after adding the applicable spread or margin charged by the bank. 

5. Understand the reset period 

• Find out how frequently your MCLR-linked loan rate will be reset. Changes in MCLR may apply to your loan only on the specified reset date. 

6. Check applicable charges 

• Ask your lender whether conversion, administrative or documentation charges apply when switching benchmarks. 

7. Submit the conversion request 

• If the switch appears beneficial, submit the required request and documents to your lender. 

8. Review your revised repayment schedule 

• Once the conversion is completed, check your new interest rate, EMI, remaining tenure, spread and next reset date. 

Remember that switching to MCLR may not necessarily result in savings for every borrower. The benefit depends on factors such as your existing interest rate, the new effective rate, applicable spread, reset period, remaining loan tenure and conversion charges. 

Base Rate vs MCLR: Which One is Better? 

MCLR was introduced to improve some of the limitations of the Base Rate framework, particularly in relation to monetary policy transmission and responsiveness to changing funding costs. 

Since MCLR considers the marginal cost of funds, it can generally respond more efficiently to changes in banks’ current funding costs. 

However, MCLR is not automatically better or cheaper for every borrower. 

Your final loan interest rate also depends on factors such as: 

• The spread charged by your bank 

• Your existing interest rate 

• The remaining loan tenure 

• The MCLR reset period 

• Conversion or administrative charges 

• The lender’s applicable terms 

Therefore, existing borrowers should compare the total expected cost of their loan before switching from Base Rate to MCLR. 

For new borrowers, it is also worth checking which benchmark applies to the loan product, as many new floating-rate retail bank loans are now linked to external benchmarks instead of Base Rate or MCLR. 

Understanding the lending benchmark applicable to your loan can help you assess how changes in interest rates may affect your EMIs and overall borrowing cost. 

If you are looking for funds for planned or urgent personal expenses, you can also consider a Fibe Personal Loan. 

Eligible customers can get a personal loan of up to ₹10 lakh with flexible repayment tenure of up to 36 months, subject to applicable eligibility criteria and terms. 

The funds can be used for different personal needs such as travel, home renovation, medical expenses, education, wedding expenses and other eligible requirements. 

Fibe also offers a digital application process and nil foreclosure charges, subject to applicable terms and conditions. 

Visit the Fibe website or download the Fibe app to check your eligibility and available loan offer. 

FAQs on Base Rate vs MCLR 

1.How do I change my Base Rate to MCLR? 

Contact your bank and request a conversion of your existing Base Rate-linked loan to an MCLR-linked loan. Before switching, compare the new effective interest rate, applicable spread, reset period, remaining tenure and any conversion charges. 

2.Is MCLR better than the Base Rate? 

Not necessarily in every case. MCLR was designed to improve transparency and make lending rates more responsive to changes in banks’ marginal funding costs. However, whether it is more beneficial for you depends on your existing interest rate, applicable spread, remaining loan tenure, reset period and conversion charges. 

3.How is MCLR calculated? 

Banks calculate MCLR primarily using four components: 

• Marginal cost of funds 

• Negative carry on CRR 

• Operating costs 

• Tenor premium 

Together, these factors determine the MCLR applicable to different loan tenures. 

4.Who decides the Base Rate? 

Individual banks calculate and determine their own Base Rate according to the regulatory framework prescribed by the RBI. 

The RBI does not set one common Base Rate for all banks. Instead, banks calculate their respective Base Rates based on factors such as funding costs, operational expenses, regulatory reserve costs and the required return on capital. 

5.What is the current Base Rate in India? 

There is no single Base Rate applicable across India because individual banks determine their own rates. 

As per RBI-published banking rate data, Base Rates can vary across banks. Borrowers should therefore check the latest Base Rate directly on their bank’s official website before making a borrowing or refinancing decision. 

6.Is switching from Base Rate to MCLR mandatory? 

No. Switching from Base Rate to MCLR is not mandatory for eligible borrowers whose existing loans remain linked to the Base Rate. 

Borrowers can evaluate the available option and decide whether switching is financially beneficial based on the revised interest rate, spread, remaining tenure and applicable charges. 

7.Which is more beneficial for existing home loan borrowers – Base Rate or MCLR? 

There is no single option that is better for every borrower. 

MCLR may respond more efficiently to changes in banks’ funding costs, but the actual benefit depends on the borrower’s current Base Rate-linked interest rate, the MCLR and spread offered by the lender, the remaining loan tenure, reset period and conversion costs. 

Before switching, calculate the total expected interest outgo under both options and compare the overall savings rather than looking only at the benchmark rates. 

Highlight: Find what the MCLR rate is and how it can impact various loans. Know how MCLR impacts your best personal loans if they show changes in interest rates.

The MCLR or the Marginal Cost of Funds based Lending Rate system owes its introduction to the RBI or the Reserve Bank of India.  Launched in April 2016, this new MCLR rate lending system is a modified version of the old regime for base rates. Here, the new interest rates are calculated based on the repo rate and the bank’s interest rate on customer deposits. With the new rules in place, commercial banks are now obliged to set up new benchmarks for internal rates for lending based on the marginal cost of funds.

Need for MCLR

With the old base rate system for banks, whenever there were changes in repo rate, the banks were reluctant to align their interest rate promptly as per the change. Therefore, though RBI introduced rate changes periodically, banks were not keen enough to change their own lending or deposit rates.

With the introduction of the MCLR, the banks have to adjust their interest rates as per their risk factor for various customer segments. There are different benchmark rates for different loan tenures. So, first, the banks set rates for terms starting from 1 day or one month to 1 year. Based on them, the banks can also charge interest rates for more than one year.

Also Read: How Repo Rates Affects Interest Rates

What do you mean by the MCLR Rate?

The Marginal Cost of Funds Lending Rate is the minimum rate for lending below which a bank cannot lend or issue a loan. Here ‘marginal’ means additional or a change or margin in the current state, economic sense. The MCLR rate is thus based on any changes in the banks’ marginal cost conditions.

The MCLR is revised monthly based on the repo and other borrowing rates. Banks generally cannot lend below the MCLR, except in a few exceptional conditions.

In the following conditions, banks can lend below the MCLR:

• For loans against deposits 
• Loans to bank employees of the respective bank

Type of MCLR-linked Loans

With the latest RBI guidelines, all floating-rate loans sanctioned after 01.04.2016 will follow the MCLR, including their credit renewal. Existing borrowers with floating-rate loans can also switch to the MCLR rate as per the options given. These floating-rate loans include home loans, corporate term loans and loans against property.

MCLR is related to banks so any floating interest rate loan sanctioned by them will be linked to the MCLR. Some banks link their educational loans and auto loans with the MCLR. So, if you have a floating interest rate for your best personal or car loan, it will also be connected to MCLR.

Also Read: Floating Interest Rates vs Fixed Income Rates

Does MCLR impact personal loans?

Personal loans are a good option for short-term liquidity. It is important to note that the MCLR will not affect your best personal loans with a fixed interest rate. The variable rate of your best personal loans will become more affordable in the long run with lower EMIs.

Components of MCLR Rate

The MCLR rate is composed of different components. They are as follows:

• The marginal cost of funds that includes return on net worth and the marginal cost of borrowings
• Operating costs incurred by the banks
• Negative carry due to cash repo rate. All banks have to pay a cost to keep their reserves with RBI, which constitutes this carry.
• Tenor premium or the risk premiums charged by banks for long-tenure loans.

The banks charge the marginal costs as per the new guidelines set by the RBI based on these factors:

• Savings, current, term, and foreign currency deposits interest rates.
• Borrowings that include the short-term and long-term interest rate, and the repo rate
• Return on net worth

The marginal cost of funds, repo rate, and deposit rates determine 92% of the MCLR, while the return on net worth comprises the remaining 8%.

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Impact of MCLR Rate on Loans by Banks

The various loans offered by banks will have the following impacts given the MCLR.

• Regulated Interest Rates – With the old base rate lending system, the banks were quick to increase interest rates on floating-rate loans whenever there was an increase in rates, as announced by the RBI. However, when the RBI cut down the interest rates, they did not slash the rates with the same promptness. This resulted in a discrepancy in the interest rates. With the introduction of the MCLR rate, banks need to regularly change their rates as per changes in marginal cost conditions.
• Impact on the spread – Before introducing the MCLR, banks charged low spreads for low-interest rate loans. This would initially attract many customers, but later, banks unreasonably increased the space without valid reasons. This resulted in increased interest rates for the customer, as there was an increased spread even if the base rate was not increased.
  With the MCLR system, banks are mandated to fix a spread while sanctioning the loan. This spread will not be subject to increase until there is a change in the customer’s credit profile. Also, banks are required to reset their loan interest rates at least annually.

• Transparent Loan Pricing – The MCLR system has proved to be more transparent from the customer’s point of view with a special price of floating-rate loans. The banks are now required to set the spread when sanctioning the loan without unreasonable increases during the loan tenure.
• Bank Margins – The MCLR rate brings about a more fair and transparent system for interest rates and loan pricing in the case of variable interest rate loans. RBI requires banks to publish their lending rates every month for a minimum of five different tenures. This has to be followed strictly by all banks. Banks can now not increase the spread they charge customers during loan tenures.

Exemptions for MCLR Loans

MCLR rate arrangement is only applicable to banks. It does not apply to loans taken from Non-Banking Financial companies and other financial institutions or NBFCs like HDFC, LIC Housing Finance, DHFL, Indiabulls, etc.

Banks need to apply the MCLR system for all loans except car loans, fixed-rate home loans and personal loans with fixed interest rates.

Loans given by banks under the Central Government or State Government schemes are also exempt from MCLR, where the banks charge a specified interest rate as per government directives.

Conclusion

As applicable, banks cannot charge their lending rate below the MCLR rate for any loan maturities. However, most secure loans, Government of India special loan schemes, loans to bank employees and fixed-rate loans for more than three years are exempted from MCLR.