Why was MCLR framework made to replace repo rate system for bank interest rates?
One of the biggest concerns of most loan borrowers was that bank interest rates did not go down as and when the RBI reduced its repo rate. To bring parity between repo rate and bank interest rates, RBI mandated banks to adopt the MCLR framework which uses a marginal costs methodology for banks to arrive at their lending rate.
The new MCLR framework aims to significantly improve the transmission of cuts in policy rates to the end-borrowers by mandating banks to set rates based on their marginal cost of funds rather than their average cost of funds.
It may be noted that this change is only for banks and not applicable to Non-banking financial companies (NBFCs).
The difference in repo rate and MCLR are as below.
In a falling interest rates scenario, under MCLR, if a borrower avails of the loan on 1st April 2016, and if the bank decides to cut rates on 5th April 2016, the borrower will get the benefit only after a gap of one year. But, at the same time, borrowers would be protected when the rates climb. Even if the rates go up, the new rates would be applicable when they are due for reset.
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