Before 2016, two banks could quote different home-loan rates for the same borrower, on the same day, with no clear reason why. RBI’s Marginal Cost of Funds based Lending Rate (MCLR) was built to close that gap — and it’s being rewritten again in 2026.
📌 Must Know
What MCLR Is, and Why It Replaced the Base Rate
- Launch The Marginal Cost of Funds based Lending Rate (MCLR) took effect on 1 April 2016. It replaced the Base Rate system, which RBI had introduced in July 2010.
- Internal Benchmark MCLR is an internal benchmark. Each bank calculates its own MCLR, using its own cost of funds, not a rate set directly by RBI.
- Coverage All rupee loans sanctioned, and all credit limits renewed, from 1 April 2016 onward had to be priced with reference to MCLR.
- Switch Option Existing Base Rate borrowers could switch to MCLR without paying a switch fee, giving them access to faster rate transmission.
MCLR’s Four Components
- Marginal Cost of Funds The cost of raising one additional rupee of funds, weighted across deposits, borrowings, and a bank’s own net worth.
- Negative Carry on CRR Banks earn no interest on the Cash Reserve Ratio portion they must park with RBI. This cost gets added into MCLR.
- Operating Cost The bank’s own cost of running its lending operations, excluding costs already recovered through separate service charges.
- Tenor Premium Longer-tenor loans carry a higher premium, reflecting the extra risk a bank takes on over a longer repayment period.
Purpose: Transparency and Fairness
- Transparency MCLR guidelines made the methodology banks use to set advance rates far more transparent than under the Base Rate system.
- Fairness The guidelines aim to ensure bank credit is priced fairly, for borrowers and for banks’ own lending margins.
- Five Tenors Banks publish MCLR for five tenors: overnight, one month, three months, six months, and one year.
- Monthly Review Banks review and publish their MCLR every month, on a pre-announced date.
💡 Good to Know
Reset Dates and Residual Maturity
- Reset Periodicity Every MCLR-linked loan carries its own reset date, at intervals of one year or less, fixed at the time of sanction.
- Residual Maturity A loan’s rate is linked to the MCLR of a tenor matching its residual maturity, not necessarily the loan’s original tenor.
- Spread A bank can add a spread over MCLR, based on a borrower’s credit risk and business strategy, but MCLR itself is the floor.
Why the Base Rate Fell Short
- Slow Transmission Under the Base Rate system, banks were slow to pass RBI’s rate cuts on to borrowers. Loan rates often changed only when a bank chose to.
- Same Problem Persisted Even under MCLR, transmission stayed weak. Between 2015 and 2019, RBI’s repo rate fell by 135 basis points. Weighted average lending rates on fresh loans fell by only about 82 basis points in the same period.
- The Gap That gap is the direct reason RBI later introduced External Benchmark Lending Rate (EBLR) loans, covered under Great to Know below.
Test Yourself
🌟 Great to Know
2019: EBLR Takes Over for Retail and MSME Loans
- Mandatory From RBI made External Benchmark Lending Rate (EBLR) compulsory from 1 October 2019, for all new floating-rate retail and MSME loans.
- External, Not Internal EBLR links a loan’s rate to an external benchmark, not an internal one banks calculate themselves. That benchmark can be the repo rate, a Treasury Bill yield, or another rate published by Financial Benchmarks India Pvt. Ltd.
- Faster Reset EBLR-linked rates must reset at least once every three months. This forces much faster transmission than MCLR’s slower, bank-discretion-heavy reset cycle.
- MCLR Still Alive MCLR did not disappear. It still applies to large-corporate loans and to any floating-rate retail/MSME loan sanctioned before October 2019 that hasn’t switched to EBLR.
- Shift in Numbers By December 2024, roughly 61% of banks’ outstanding floating-rate loans were EBLR-linked, official RBI data shows. That’s a sign of how far the switch has gone since 2019.
📰 Current Affairs
[Policy] 12 Aug 2026 — RBI Proposes a New MCLR Formula
- Draft Directions RBI released the draft “Reserve Bank of India (Interest Rates on Loans and Advances) Directions, 2026” on 12 August 2026, for public comment. This followed its 5 August 2026 policy statement. (Source: RBI press release)
- New MCLR Formula The draft proposes a new MCLR formula: a three-month moving average of the marginal cost of fresh deposits and fresh borrowings. This data must be system-generated and independently verifiable. (Source: Business Today)
- So What? This replaces banks’ varied, less transparent MCLR methods with one uniform, auditable formula. RBI’s own draft cited “divergent practices” as the reason.
- Faster Resets From 1 April 2027, both MCLR and EBLR floating-rate loans must reset within a maximum of three months. This closes MCLR’s slow-transmission gap for good. (Source: RBI press release)
- Migration Deadline Existing floating-rate loans, on any benchmark, must migrate to the new framework by 1 April 2029. This happens through a one-time mapping exercise, with borrower consent and no extra fee. (Source: Business Today)
- Comment Deadline RBI is accepting public feedback on the draft until 11 September 2026, through its ‘Connect 2 Regulate’ portal. (Source: RBI press release)
📝 Previous Year Question
UPSC CSP 2016 — Purpose of MCLR
- UPSC 2016 Both listed purposes are correct. MCLR guidelines improve transparency in banks’ rate-setting methodology, and help keep credit fairly priced for both borrowers and banks. See UPSC CSP 2016 GS Paper I, Q43.
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