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Marginal Cost of Funds based Lending Rate (MCLR)

Introduction

The Marginal Cost of Funds based Lending Rate (MCLR) is a key benchmark used by banks to decide lending rates for loans. It was introduced to ensure faster transmission of RBI’s policy rate changes to borrowers.

In SBI and IBPS exams, MCLR questions are usually definition-based, purpose-based, or comparison-based with the Base Rate.

Pattern: Marginal Cost of Funds based Lending Rate (MCLR)

Pattern

The key idea is that MCLR links loan interest rates to the marginal (latest) cost of funds of banks, making lending rates more responsive to policy changes.

Step-by-Step Example

Question

Why was the Marginal Cost of Funds based Lending Rate (MCLR) system introduced?

Options:
A. To provide insurance cover to deposits
B. To fix interest rates permanently
C. To improve transmission of policy rate changes
D. To promote bank mergers

Solution

  1. Step 1: Recall the issue with the earlier Base Rate system

    Under the Base Rate system, changes in RBI policy rates were not quickly reflected in lending rates.

  2. Step 2: Identify the objective of MCLR

    MCLR was introduced to ensure faster and more transparent transmission of policy rate changes to borrowers.

  3. Step 3: Eliminate incorrect options

    Deposit insurance, permanent rate fixing, and mergers are unrelated to MCLR.

  4. Final Answer:

    To improve transmission of policy rate changes → Option C

  5. Quick Check:

    Faster RBI rate transmission = MCLR objective ✅

Quick Variations

• Questions may ask the full form of MCLR.

• Often tested: Difference between MCLR and Base Rate.

• Sometimes asked: How often loan rates reset under MCLR (reset period concept).

Trick to Always Use

  • Step 1 → If the question mentions loan pricing, think MCLR.
  • Step 2 → Marginal cost = latest cost of funds.
  • Step 3 → Faster rate transmission → MCLR, not Base Rate.

Summary

Summary

  • MCLR is a benchmark rate used to decide lending rates.
  • It is based on the marginal cost of funds of banks.
  • MCLR improves transmission of RBI policy rate changes.
  • It replaced the earlier Base Rate system.

Example to remember:
“New cost of funds → New lending rate under MCLR.”

Practice

(1/5)
1. The term ‘Marginal Cost’ in MCLR refers to:
easy
A. The latest cost incurred by banks to raise funds
B. Average cost of all past borrowings
C. Administrative cost of bank branches
D. Profit margin added to loans

Solution

  1. Step 1: Understand the word ‘marginal’

    Marginal means the cost of the most recent or additional funds.

  2. Step 2: Link with loan pricing

    MCLR is calculated using the latest cost at which banks raise funds.

  3. Final Answer:

    The latest cost incurred by banks to raise funds → Option A

  4. Quick Check:

    Marginal = newest cost, not past average ✅
Hint: Marginal always means latest, not average.
Common Mistakes: Confusing marginal cost with average cost of funds.
2. MCLR system replaced which of the following lending rate mechanisms in India?
easy
A. Prime Lending Rate (PLR)
B. Base Rate
C. Repo Rate
D. Bank Rate

Solution

  1. Step 1: Recall the earlier benchmark system

    Banks earlier used the Base Rate to price loans.

  2. Step 2: Identify the replacement

    MCLR was introduced to replace the Base Rate system.

  3. Final Answer:

    Base Rate → Option B

  4. Quick Check:

    Base Rate → replaced by MCLR ✅
Hint: PLR → Base Rate → MCLR (chronological memory).
Common Mistakes: Assuming MCLR replaced Repo Rate directly.
3. Compared to the Base Rate system, MCLR makes lending rates:
easy
A. Completely fixed for the entire loan tenure
B. Unrelated to RBI policy rates
C. More responsive to policy rate changes
D. Uniform across all banks

Solution

  1. Step 1: Recall why Base Rate was replaced

    Base Rate was slow in passing RBI rate changes to borrowers.

  2. Step 2: Identify improvement under MCLR

    MCLR ensures quicker transmission of policy rate changes.

  3. Final Answer:

    More responsive to policy rate changes → Option C

  4. Quick Check:

    Faster RBI impact = MCLR advantage ✅
Hint: Speed of transmission differentiates MCLR.
Common Mistakes: Thinking MCLR fixes loan rates permanently.
4. Which authority introduced the MCLR framework in India?
medium
A. Reserve Bank of India
B. Government of India
C. Indian Banks’ Association
D. Ministry of Finance

Solution

  1. Step 1: Identify the regulator of banks

    RBI regulates banking operations and interest rate frameworks.

  2. Step 2: Link with lending rate reforms

    MCLR was introduced as part of RBI’s monetary transmission reforms.

  3. Final Answer:

    Reserve Bank of India → Option A

  4. Quick Check:

    Loan rate framework reforms come from RBI ✅
Hint: Any lending benchmark reform → RBI.
Common Mistakes: Attributing MCLR introduction to the Government.
5. Under the MCLR system, changes in lending rates are usually linked to:
medium
A. Daily stock market movements
B. Annual government budget
C. Customer repayment behaviour
D. Predefined reset periods

Solution

  1. Step 1: Recall how MCLR loans work

    Lending rates are not changed daily.

  2. Step 2: Identify the mechanism

    MCLR-linked loans change rates only at reset periods.

  3. Final Answer:

    Predefined reset periods → Option D

  4. Quick Check:

    No reset = no rate change under MCLR ✅
Hint: Reset period controls rate change timing.
Common Mistakes: Assuming MCLR changes loan rates instantly after every RBI action.

Mock Test

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