Rishi and Kabir bumped into each other at their favourite fast-food joint and their conversation unfolded thus:

Rishi: This interest rate thing is strange. The RBI increased the repo rate, but HR Bank’s interest rate is lower than mine at SS Bank.

Kabir: Your bank’s MCLR might be higher than that of HR Bank.

Rishi:  What is that?

Kabir: MCLR (marginal cost of funds-based lending rate) is the rate threshold below which banks cannot lend. This rate is arrived at as per a formula specified by the RBI and is different for each bank based on the variables. MCLR is calculated as the Marginal Cost of Funds (Repo rate) + Operating costs+ CRR+ Tenor premium (a premium charged by banks for higher tenors). Once the MCLR is decided, a spread is added to arrive at the final interest rate. So, HR Bank might be able to offer lower interest than your SS Bank because it might be having a lower MCLR.

Rishi: Interesting. But has this always been the case?

Kabir: MCLR was introduced in 2016. Earlier, lending was done with the base rate as reference. The base rate is calculated by adding the average cost of funds or the interest rate on deposits and the cost to maintain CRR, along with the margin of profit. This differs from MCLR in that, instead of the repo rate, it is based on the average cost of its deposits.

Rishi: Ok, but why was MCLR introduced when Base rate looks fair enough?

Kabir: Base rate takes the average cost of deposits as on date and therefore consumers cannot benefit from repo rate changes while the MCLR changes as per the repo rate.

Rishi: I have also heard about something called BPLR. What is that?

Kabir: Benchmark prime lending rate (BPLR) was the rate introduced by the RBI in 2003. This was the rate at which banks lent to their most creditworthy customers. However, there was less transparency in this system and banks even lent at rates lower than the BPLR to certain privileged clients. This was the reason BPLR was replaced with the base rate.

Rishi: Which rate types prevail now, and which one is better?

Kabir: From April 1, 2016, all loans are, by default, MCLR-based, but loans taken prior to this period will be referenced to the base rate with an option to switch to MCLR. Under base rate, the change in repo rate is not reflected immediately, whereas in the MCLR the change is reflected immediately as these rates must be decided monthly. If a borrower believes that in coming periods repo rate will come down, then the borrower may plan to switch to MCLR mode and if the loan is about to close soon, then the borrower may stick to the base rate system.

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