Difference Between MCLR and Repo Rate of the RBI

Reserve Bank of India revises Repo Rate that affects interest rates on home loans and other retail loans. MCLR directly fluctuates with changes in Repo Rate, we will discuss the magnitude of effect in the latter part of the passage.

Repo and MCLR decide how much you as a borrower will pay on your loan as EMI and other charges. If you want to know how RBI and market trends modify your payable amount, it is essential to know about Repo, MCLR, and their difference.

We will explain the definition, prevailing rates, and differences in the following passage.

What is MCLR?

Reserve Bank of India fixes the threshold for the minimum interest rate for lending loans. All commercial banks and loan distributors cannot lend loans to borrowers below the interest rate fixed under the Marginal cost of funds-based Lending Rates (MCLR).

MCLR came into existence on 1st April 2016. RBI announces required changes during economic distress from time to time.

Current Rates of MCLR as of September’21

SL No. Tenor wise MCLR Rate Effective from 1st September, 2021
1 Overnight MCLR 6.60 percent
2 1 Month MCLR 7.10 percent
3 3 Months MCLR 7.15 percent
4 6 Months MCLR 7.20 percent
5 1 Year MCLR 7.25 percent
6 3 Year MCLR 7.70 percent

(Source-Bank of India)

What is Repo Rate?

Repo Rate is the rate of interest commercial banks utilise to borrow money from the Reserve Bank of India. Banks and financial institutes generally approach RBI during fund crunch. Repo Rate is an inflation control measure applied by Government Authorities and RBI.

RBI use Repo and Reverse Repo Rate under liquidity adjustment procedure. RBI increases the repo rate to check high inflation and reduces it during lower than required inflation.

During high inflation, a high repo rate works as a disincentive to borrow from the RBI. Fewer funds with banks led to a low supply of funds in the economy and helps in controlling inflation.

Similarly, RBI decreases or maintain the status quo in case of low inflation. The purpose of the Repo Rate is to provide a healthy inflation rate. RBI provides funds to the bank to utilize this fund to offer home loans to the customers.

Repo Rate in RBI Monetary Policy 2021

RBI’s six-member Monetary Policy Committee headed by Governor Shaktikanta Das announced that the repo rate will remain unchanged at 4 per cent. RBI will keep an ‘accommodative stance’ with Repo Rate as long as it requires to mitigate the adverse impact of the Covid-19 pandemic.

(Source- Indian Express) 

Difference Between Repo Rate and MCLR

Repo Rate linked loans experience the impact of interest rate changes faster after the RBI announcement. But Repo Rate does not guarantee cheaper loans. Repo Rate is at its fifteen year’s low currently which make it attractive for home loans, mortgage loans, etc.

Repo linked interest rates increase faster when RBI increases Repo Rate for lending commercial banks and loan distributors. Whereas MCLR-linked loans take comparatively more time in transferring the impact of a high repo rate.

Loan distributors and banks increase interest to cover risk premium and operating costs in repo-linked loans. Rates vary in different financial institutes and extra rates are imposed on borrowers. despite rate is related to the same benchmark.

The Reserve Bank of India has mandated all financial institutions under its supervision to link new floating rates for personal & MSME loans and retail loans to an external benchmark such as Repo Rate.

According to this guideline, financial institutions need to link loan lending rates with Repo Rate, six-month Treasury bill or three-month treasury bill.

MCLR also varies from bank to bank because every bank’s marginal cost of funds is different. Commercial banks and financial institutions measure their cost of funds according to the interest rates offered by RBI on borrowing s and deposits.

MCLR should fluctuate in tandem with RBI’s move on Repo Rate. However, this fluctuation is relatively low because banks rely on only one per cent of required funds on RBI. So, changes in Repo Rate do not affect MCLR much.

Concluding Thoughts

We will quote from Mythili Bhusnurmath, Consulting editor at ET Now for a neutral perspective here. She said, “Interest rates are not a one-way street, and it is unlikely that the customer will be at advantage as a depositor or borrower. For the ‘aam loan applicant’, managing with higher fluctuation and uncertain payments can greatly outweigh any advantages of lower interest rates, even assuming financial institutions do not add up premium and fees to secure their margins.”

Bottomline is Repo Rate and MCLR are both instruments of RBI to control inflation, boost the funding capacity of commercial banks, and increase fund flow into the market. Strong books of the financial institutions will encourage them to provide attractive interest rates on loans. Therefore, people will be encouraged to buy home loans, mortgage loans, etc.

aged to buy home loans, mortgage loans, etc.

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