MCLR (Marginal Cost of Funds Based Lending Rate) - Explained in Hindi - YouTube

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Namaskar, My name is Mukul and welcome to Asset Yogi.

Friends have you ever thought,

that when you go to the bank for a loan,

So the interest you get charged, how's that derived?

Can a bank charge you any interest rate?

For example, if you go to take a home loan,

if the interest rate in the market is 8.5-9%.

Then, can a bank give you a home loan at 5%?

If I give you the short answer, then no.

It depends on the MCLR of that bank.

The full form of MCLR is,

Marginal cost of funds-based lending rate.

Now, how much should be this MCLR?

For that, there are RBI guidelines, that every bank should follow.

Bank basically declares it's MCLR, and according to that,

what are other interest rates of home, personal, or other loans?

Bank also declares all of those from time to time.

Now basically what's the concept of MCLR?

How did its historical evolution happen?

Because before MCLR, there was Base rate,

Before the Base rate, it was BSLR.

So what was the need that, we went to Base rate from BSLR?

And went to MCLR from BAse rate?

What profits did consumers get from it?

We'll discuss all of it in this video.

And as a consumer what profits have you gotten?

I'll tell you about that also.

So watch this video till last. Let's go straight to the blackboard.

In our last video, we saw that RBI incorporates its monetary policy

mainly from the Repo rate.

That is our key policy rate.

So whenever RBI increases the Repo rate, so RBI wants that

the interest rate, which these commercial banks are charging to consumers, increases too.

If it decreases the Repo rate, then it wants the interest rate to decrease too.

Now basically why does RBI increases the Repo rate?

RBI increases the Repo rate cause it wants to control inflation,

wants to control dearness.

So it creates a balance between inflation and growth.

And the balance between growth and inflation is gained by increasing or decreasing the Repo rate.

I have already made a detailed video on the Repo rate

and Reverse Repo rate, you can watch that video.

Mainly we want to understand that the repo rate is very important for RBI.

RBI wants that the repo rate and the interest rate finally getting charged to customers,

there becomes a direct correlation in it.

So that whatever monetary policy RBI wants to implement,

it can implement directly.

If it wants to reduce inflation, then it can do that.

If it wants to focus on growth, then the growth should increase.

But,

This exact link does not establish easily.

For this we'll have to understand the timeline that,

how did interest rates evolve in India?

In 1994 interest rates were deregulated completely.

and in April 1003, BPLR policy was launched.

What did BPLR mean?

IF we talk about full form, benchmark prime lending rate.

RBI said every bank will have to announce its BPLR,

will have to disclose, and it'll be such an interest rate

which is the minimum interest rate, they will charge to most creditworthy customers.

Whose credit profile is very good, they should be offered the lowest interest rates.

But there were some issues with it.

Every bank to declare BPLR approved by their Boards.

Boards had to approve it.

There was no formula prescribed for it by RBI.

SO what issues were there?

I already talked about that there was no fixed formula.

NOw there was no fixed formula so there was no transparency.

Banks could set any BPLR according to them.

They used to give different rates to different customers.

So corporates or groups could lobby if someone had good relations with the bank.

So they could take the lowest rate from the bank.

What's happening in this case was,

that bank used to declare or announce its BPLR,

But still, sub-BPLR lending happened, sub-BPLR lending means?

We already said that BPLR meant that it should be the minimum that you'd give to your most creditworthy customer.

So you should not charge an interest rate lower than that.

But in march 2007, an RBI report was published.

They saw that in March 2007,

In 77% bank's portfolio, there was sub-BPLR lending.

that going minus or negative of BPLR,

interest rates were quoted. In fact, we saw here that,

77% of bank loans had sub-BPLR interest rates.

Now, what problem was RBI facing?

That it wanted to control interest rates with repo rate, it couldn't do that.

Even if there were any changes in repo rate,

commercial banks did not forward those changes ahead.

So they launched a Base rate policy in July 2010.

What did it say? base rate will be your minimum interest rate,

which bank will charge its most creditworthy customers.

Obviously, BPLR was replaced by the base rate.

In the base rate, an indicative formula was given.

There was no formula in BPLR, right?

An indicative formula was given that how the bank should calculate the base rate.

and it was said that if,

most creditworthy customer is being charged base rate,

so the bank will clearly tell the spread to all other customers.

that you're being charged this much on top of the base rate.

For example, a commercial bank says that,

our base rate is of let's say 9%

and if you take a home loan from us,

then we'll charge you a 1% spread, based on your credit profile.

so your total interest will be 10%.

It was a good policy but there were some issues. Now, what were these issues?

Here RBI had given the flexibility that bank on their on,

can calculate its average cost of funds,

marginal cost of funds or blended cost of funds.

So what does that mean? Let's understand again carefully.

here we talked about deposits that wat's the main cost of banks?

one is that they have to give deposit rates,

what are the deposit rates? let's talk about them.

and they have to give interest rates on borrowing as well.

Now that can be repo rate,

or banks have to give some interest rate, or

it could be interest for bonds or debentures.

So there was still no transparency in the calculation of the base rate, because

there was no fixed formula here.

See, it was n indicative formula here, but no fixed formula.

We'll also see the formula,

what was formula, and the components of the base rate.

The base rate started having the same problems, which were in BPLR,

that there was no transparency and different banks calculated their base rate differently.

So generally average costs of funds were taken,

Now the average cost of funds, we are talking about

the deposit rete here, terms deposits are mainly a lot here.

So assume that the term deposit is of 2 years,

so the term deposit will stay for 2 years.

If the bank is giving 7% on it, so It'll give the same 7%.

Now,

If RBI wants to establish a connection between repo rate and base rate

it cannot do that because,

manly base rate is being calculated, long term deposits are here,

so their proportion has increased a lot.

If the repo rate changed a bit, then how will it reflect the change?

So that's why, even if the repo rate was changed,

RBI couldn't implement its monetary policy directly.

Assume RBI reduced the repo rate,

even then banks did not reduce their interest rates.

So the problem started coming here also.

So that's why in April 2016, the MCLR policy was introduced,

What was the MCLR policy?

Marginal cost of funds based lending rate,

So it meant the same too.

the minimum interest rate that bank charges to its most creditworthy customer,

so the Base rate was replaced with MCLR

but here the calculation was a bit different.

so the biggest difference here was

that exact formula was prescribed by RBI,

that you'll have to calculate your MCLR like this.

And after declaring your MCLR,

when charging customers the interest rates, you'll clearly tell

that this is our MCLR and we're charging this much spread.

For example, the customer goes to a commercial bank for a home loan,

It says that on today's date our MCLR is 8%,

and on top of the spread we'll charge you based on your credit profile,

let's say that is, 0.5%.

So your interest rate will be 8.5%.

So let's see what were the expectations here.

One was that the transparency will increase in MCLR cause,

we've given the exact formula.

so now the banks will declare MCLR transparently,

and customers will be profited.

and second, whenever we'll increase or decrease repo rate,

so it'll directly reflect on interest rates.

So the borrowing here, we talked about it before,

one is your deposit cost, here deposit percentage.

and we saw in borrowings that

borrowing from RBI mainly, repo percentage is the cost of bank.

so here the main expectation was that the MCLR and repo rate,

there would be a good link between those.

So that was the timeline, that how did these policies evolve.

Now we'll see the difference between base rate and MCLR. what was the difference in the calculation?

First of all, the components of the base rate,

it is an indicative formula. I'll write it down again.

I had told you before.

So here first we take the cost of funds of banks.

What are the costs of funds?

One is the cost of the deposit, we just talked about.

What kind of deposits? Deposits of current accounts,

deposit of savings account, and term deposits.

Like FD or recurring deposits.

The second cost is of borrowings.

Which borrowings? One is from RBI, banks take loan on repo rate,

the loan can be taken from other banks,

also, they issue bonds and debentures,

they have to give fixed interest so that's also a cost.

What are the components other than that? One is the cost of banks,

we'll include that in the base rate,

other than that there is a negative carry on CRR and SLR

What does that mean?

In CRR requirement we talked about how RBI holds CRR requirement.

It is placed in form of hard cash at RBI.

And RBI gives no interest on it. Now when it gives no interest,

so it's a cost of banks, and it is included in the base rate.

Other than that, this SLR, the statutory liquidity ratio

Many times returns on it are low and cost of banks is increased.

So if the returns of SLR are low from cost of funds,

so then the difference is also counted in negative carry.

and banks could take in base rate components.

other than that, un-allocable Overhead costs.

what does un-allocable mean?

the cost which is of the overall bank, or centralized cost,

you can take its component.

but if it's an individual business unit, then you can't include its cost.

Fourth is your average return on net worth.

What does return on net worth mean?

Every bank has an expected return, which we call hurdle rate.

Expected returns are that how much

shareholder's money is invested, we have to give a percentage in form of returns.

How much will that be? we call it , return on net worth.

So average returns on net worth do not change, cause each bank has fixed expectations.

RBI said that your return on net worth should not change.

Whatever your expectations for return on net worth, take that

and include it in the base rate component also.

But,

the biggest challenge was that it was an indicative formula,

no exact formula was told.

It wasn't told how much average return on the net worth percentage you have to take,

in base rate component.

how much cost of funds percentage do you have to take?

how much percentage of other things do you have to take?

All these things were not told exactly in the base rate.

That's why, one bank is taking the average cost of funds, while

one is taking marginal cost and other is taking blended cost.

So base rate calculation for different banks was happening differently in their own way.

and there was no impact of repo rate on that.

So what did they change in MCR? First of all,

you'll take your marginal cost of funds.

What does the marginal cost of funds mean?

that whatever new loans bank will take,

its cost, new loans or new deposits.

their cost will be taken.

Also, it was clearly written that how much percent it'll be.

So 92% weightage of marginal borrowing cost would be taken,

and 8% weightage of return on net worth.

And what will be included in marginal cost of funds?

First of all, it'll be the marginal rate of deposits.

What will be the marginal rate? I already talked about that.

new deposits here,

how much percentage rate of that are you giving to customers?

The new customers, LEt's say you're giving them,

4% deposit rate, then you have to consider that.

If in the past you've given 5-6%

so you can't consider that.

If you have given 4% to new customers then you have to consider that.

Similarly in borrowings, you have to consider marginal rate.

In short term, you take money from RBI on repo rate,

so whatever repo rate was charged on that new loan,

For example, repo rate in today's date is 6%,

so if you've taken money at 6% ao you have to consider that.

In past even if you've taken money at 7%,

you can't include that.

Besides these what other components can you include?

now can you, sorry. you definitely have to.

So negative carry on CRR. there is no SLR here.

Like here SLR was also included.

here you can consider CRR only,. So you don't get interest rate for CRR from RBI,

so you can include that here.

third, you can include your operational cost.

Whatever operating expense there are to operate banks.

Fourth you can include tenor premium. For example,

It is possible that some banks, for long term loans,

can charge some premium.

I'll tell you exactly what this tenor premium means. Like,

your interest rate could change every 6 months,

possible it changes in 1 year,

So the MCLR for 1 year, it's possible that some bank charge more interest rate for that,

and it's possible that some bank charge less.

So you have to include this tenor premium in MCLR.

So this way exact formula for MCLR was told.

Here it was an indicated formula, here it was a prescribed formula.

So that was the difference basically between MCLR and base rate,

Now we'll see some more important points related to MCLR.

First, MCLR is applicable to only commercial banks.

It's not applicable on NBFCs.

For NBFC, there is PLR, prime lending rate.

We'll discuss that in our next video.

Second, It is applicable mainly on floating interest rates,

and fixed interest rates upto 3 years.

Another thing, banks have to publish MCLR each month.

And they have to give minimum 5 tenors.

What are these 5 tenors? one is overnight MCLR,

they have to declare, if MCLR changes in one day, how much will that be?

One month MCLR, three month MCLR, six month MCLR and one year MCLR.

What do these mean? They mean,

that whatever your interest reset period is,

that is your tenor premium.

It means, Let's say you took a home loan and it's said that

you'll be charged one year MCLR plus spread home loan rate,

And let's say your MCLR was 8.5%,

And you were charged spread of 0.5%,

So you'll get a total of 9% home loan rate.

You're told this clearly when you're offered home loan.

But every bank declares these 5 minimum tenors.

I'll show you an example.

This is SBi has declared the latest MCLR on today's date 1 oct 2018.

So see here, overnight, one month, three months, six months, and one year,

these minimum 5 they have done.

They have declared two and three years MCLR as well.

And their existing MCLR of 30sep, it's here.

And revised MCLR, which will be applicable from 1oct 1018,

they have given it here.

And you can see here, as the tenor increases,

one year is greater in comparison to overnight.

So this was the talk abut concept of MCLR.

I think MCLR concept is clear now. why did MCLR was introduced?

Why was BPLR changed to base rate? Why did we go toMCLR from base rate?

Now what effects did MCLR have?

First thing, interest rates are slightly lower in comparison to base rate.

So if your interest rate is from base rate today,

then you can change it to MCLR, and it'll be definitely reduced.

But some issues are there even now.

What are those issues? it's that the changes in repo rate,

they aren't reflected in interest rates properly.

So whatever changed RBI did previously, their immediate effect is not here.

RBI is still concerned and we'll have to see what policy does RBI brings for that.

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