MCLR vs EXTERNAL BENCHMARK RATE

Subject : Economics

Concept :

Marginal Cost of Lending Rate

It is a benchmark lending rate for floating-rate loans which came into effect in 2016.
This is the minimum interest rate at which commercial banks can lend.
This rate is based on four components—the marginal cost of funds, negative carry on account of cash reserve ratio, operating costs and tenor premium.
MCLR is linked to the actual deposit rates. Hence, when deposit rates rise, it indicates the banks are likely to hike MCLR and lending rates are set to go up.
The transmission of policy rate changes to the lending rate of banks under the current MCLR framework has not been satisfactory.

External Benchmark

So, RBI mandated all banks to link their floating rate loans to an external benchmark instead of the marginal cost-based lending rate (MCLR).
This was done to make sure that the RBI’s action on key policy rates at transmitted in a timely and transparent manner to the ender user, i.e., the borrower.
Banks can choose from one of the four external benchmarks — repo rate, three-month treasury bill yield, six-month treasury bill yield or any other benchmark interest rate published by Financial Benchmarks India Private Ltd.

Financial Benchmarks India Private Ltd

It was incorporated on 9th December 2014 under the Companies Act 2013.
It was recognised by the Reserve bank of India as an independent Benchmark administrator on 2nd July 2015.
The main objective of the company is to act as the administrators of the Indian interest rate and foreign exchange benchmarks and to introduce and implement policies and procedures to handle the benchmarks.
It is located in Mumbai.