a). Definition of MCLR:

MCLR stands for “Marginal Cost of funds based lending rate”.

MCLR refers to the minimum interest rate of a bank below which it cannot lend loan to anyone. This is independently arrived by every bank considering its own cost of funds, administrative cost and expected profits. The banks have discretion to revise MCLR from time to time based upon its cost of funds.

Since the cost of funds to a bank is different based upon the period of deposits, banks have various types of MCLR options: Daily floating MCLR, Monthly MCLR, Quarterly MCLR, Half- yearly MCLR, and Yearly MCLR. Banks have different MCLR rates based upon period as above. Generally longer the period of MCLR, higher is the MCLR rate. An entrepreneur has to wisely select MCLR period option to minimize its cost of funds.

When the bank revises its MCLR the effect of the same shall be applicable on your loan depending upon the periodicity (monthly/quarterly/half- yearly/yearly) of the MCLR in your sanction letter. The applicable ROI shall not be modified for your loan before the next MCLR reset date opted by you. For example, if you have opted for a yearly MCLR, the ROI for you shall be fixed based upon the yearly MCLR effective as on date of your MCLR reset date. Now if the MCLR changes in between before the next reset date of your MCLR, your ROI shall not be modified till the next reset date of MCLR period option you have chosen. Likewise, if you have selected monthly MCLR, your rate of interest shall change every month with the change of monthly MCLR by the bank.

b). Applicable ROI = MCLR + Spread = ROI

Now days, Banks sanction you loan and limits which are linked to MCLR. The sanction letter given to you shall mention the applicable ROI as MCLR + interest Spread determined by bank for your loan/limit. As such, MCLR plus your spread defines what interest cost shall be applicable for you for the borrowing from the bank.

MCLR is not subject to negotiations, but Rate of interest is subject to negotiations. That simply means, your focus should be on the negotiation of the spread.

c). Selecting the MCLR wisely:

The selection of MCLR period is an important decision. One should keep in mind the trends of cost of funds and funds-liquidity conditions prevailing in the market.

If the market trend is of reduction in ROI and the MCLR is expected to reduce in a short period of time, one should select short-term MCLR, say monthly or quarterly MCLR. This shall help you in faster realisation of reduction in interest rates when the MCLR is reduced by the bank.

However if the market trend is that of increase in ROI, you should select long-term MCLR of a year. This shall enable you to postpone the effect of in between increase in the MCLR by the bank.

d). When you can change the option of MCLR ?

MCLR of a bank is not subject to individual negotiations. While making selection of bank, one shall look into MCLR history of a bank and compare it with the MCLR of other banks. You have to analyse; which bank have lower MCLR over a period of time.

e). Spread of interest:

Spread is the additional rate determined for each loan/ limit, over and above MCLR, by banks for its borrower. It is expressed in sanction letter as MCLR + _______% to arrive at applicable rate of interest from time to time. This portion of ROI “spread of interest” is determined by bank considering specific cases. This is case specific. Therefore, this is negotiable.

We know, the first component of ROI, MCLR is not case specific. It is made universal by the bank for all its customers. As such MCLR is not subject to negotiation. The second portion of ROI is case specific and as negotiable. That simply means, your focus should be on negotiation of the “spread of interest” applicable for you.

f. Factors determining “spread of Interest” interest rate

i. Type of industry your business falls
ii. Track-record of the entity and its size
iii. Track-record of promoters
iv. Experience in business of entity and promoters’ in business
v. Financial ratios and profitability
vi. Project viability
vii. Past track-record of repayment
viii.Past track-record of achievement of projected performance
ix. Security levels: Primary security & collateral security
x. Government incentives and priorities
xi. Banks specific scheme for industry or in general
xii. Deposit rates prevailing in the market.
xiii.Liquidity position in the money market
xiv. Rates charged by other banks in the market.

g). Reset date: This is the date on which your interest base-rate/MCLR is scheduled to be changed/updated.

h). Exceptions to the concept of MCLR:

1. Loans sanctioned against Fixed Deposits
2. Advances to bank employees
3. Government of India formulated special loan schemes
4. Fixed Rate interest loans above three years.

Further one should note that the MCLR concept does not apply to NBFCs.