The Reserve Bank of India has issued fresh norms on calculation of base rate on the basis of the marginal cost of funds. This move is aimed at improving the transparency, ensuring speedier monetary policy transmission, and also lowering borrowing costs. The new method — Marginal Cost of funds based Lending Rate (MCLR) — will replace the present base rate system.

MCLR, as the name suggests, mandates banks to calculate the lending rate taking into account the marginal cost of funds. In the base rate system, it was left to the individual banks as to what cost it used, which typically was the average cost of funds. The RBI said all banks will follow a uniform methodology for calculation of base rate or minimum lending rate on the basis of the marginal cost of funds from 1 April, 2016.

Like base rate, banks are not allowed to lend below MCLR, except for few categories like loans against deposits, loans to bank’s own employees. In addition, fixed rate loans, which are typically personal loans and auto loans, will not be linked to MCLR. Banks have been mandated to calculate MCLR for different maturities like 1 day, 1 month, three month, six month, and one year. Banks are free to include more maturities for MCLR.

The Base Rate mechanism has been operational from 1 July, 2010. Banks fix their actual lending rates on loans and advances with reference to the base rate, a rate below which it cannot lend.