The Reserve Bank of India (RBI) has unveiled a significant proposal to revise the method by which banks calculate their Marginal Cost of Funds Based Lending Rate (MCLR). The new framework suggests that the marginal cost of funds, a key component of loan interest rates, should be determined using a three-month moving average of the marginal costs associated with domestic deposits and borrowings.
Enhancing Transparency and Consistency in Loan Pricing
This proposed methodology is part of a broader initiative by the RBI to bring enhanced consistency and transparency to how lenders set interest rates on various loans. The central bank aims to standardise the calculation of banks' funding costs, reducing variations across financial institutions.
Under the new formula, banks would compute MCLR by considering the marginal cost of domestic deposits and borrowings over the preceding three-month period. For each month within this window, an annualised weighted average interest cost would be applied, based on the volume of new deposits and borrowings acquired during that specific month. The RBI mandates that this underlying data must be system-generated and independently verifiable, further ensuring accuracy and standardisation.
Impact on Borrowers and Broader Loan Framework
MCLR is a crucial benchmark for many floating-rate loans. Changes in a bank's marginal funding costs directly influence the lending rates for borrowers whose loans are linked to MCLR. By linking this component more closely to the actual, recent cost of raising fresh funds, the RBI intends to create a more responsive and understandable interest rate environment.
The proposed MCLR adjustments are integrated into a wider overhaul of loan pricing regulations. The RBI also suggests that most floating-rate loans should be tied to either an internal or external benchmark, supplemented by a risk-based spread. The benchmark reset period for these loans would typically not exceed three months, and once chosen, the reset frequency would generally remain constant throughout the loan's tenure.
Furthermore, the draft framework introduces stricter guidelines for spreads, which would comprise a credit risk premium alongside other potential components like operating cost, term premium, and business strategy premium. While these additional components can be positive or zero, the credit risk premium must always remain positive. The RBI has also proposed that the credit risk premium should only be revised if there is a demonstrable change in the borrower’s credit profile, aligning with the lender’s internal policy and the loan agreement.
Implementation Timeline
Subject to stakeholder feedback and finalisation, the new framework is slated to come into effect from April 1, 2027. For existing loans currently linked to internal or external benchmarks, the RBI has proposed a one-time migration to the prescribed interest-rate framework by April 1, 2029. The ultimate goal of these comprehensive reforms is to provide greater clarity for borrowers on how their interest rates are determined and adjusted, fostering a more transparent and equitable lending ecosystem.