UPSC Prelims 2016 Q43: Indian Economy – Banking & Financial Sector
What is/are the purpose/purposes of the 'Marginal Cost of Funds based Lending Rate
(MCLR)' announced by RBI?
1. These guidelines help improve the transparency in the methodology followed by banks for
determining the interest rates on advances.
2. These guidelines help ensure availability of bank credit at interest rates which are fair to the
borrowers as well as the banks.
Select the correct answer
using the code given below:
- (a) 1 only
- (b) 2 only
- (c) Both 1 and 2
- (d) Neither 1 nor 2
Answer: (c) Both 1 and 2
Explanation
Marginal Cost of Funds based Lending Rate (MCLR)
Introduced by the RBI from 1 April 2016, replacing the Base Rate system of 2010.
Banks could not lend below the MCLR.
| Statement | Verdict | Fact |
|---|---|---|
| 1. These guidelines help improve the transparency in the methodology followed by banks for determining the interest rates on advances | Correct | A single formula for all banks |
| 2. These guidelines help ensure availability of bank credit at interest rates which are fair to the borrowers as well as the banks | Correct | Lending rates follow the bank's latest cost of funds |
Components of MCLR:
| Component | Meaning |
|---|---|
| Marginal cost of funds | Cost of new deposits and borrowings |
| Negative carry on CRR | Cost of cash kept idle with the RBI |
| Operating costs | Cost of running the bank |
| Tenor premium | Extra for longer loans |
From October 2019, new retail loans moved to an external benchmark such as the repo rate.
Answer: (c) Both 1 and 2.
Why each option is right or wrong
- (a) Incorrect. Statement 2 is also true: MCLR aims at fair interest rates for both sides.
- (b) Incorrect. Statement 1 is also true: MCLR improves transparency in rate setting.
- (c) CORRECT. MCLR brings transparency and fair interest rates on advances.
- (d) Incorrect. Both are stated purposes in the RBI guidelines on MCLR.
Key point
MCLR (1 April 2016): replaced the Base Rate; built on marginal cost of funds, CRR carry, operating costs and tenor premium; improves monetary transmission.
Remember
MCLR = lending rate tied to the bank's latest cost of funds.
Common mistakes
- Confusing MCLR with the Base Rate (2010) or the older BPLR.
- Thinking MCLR is fixed by the RBI; each bank computes its own.
- Forgetting the main goal: faster transmission of policy rate cuts to borrowers.
Exam tip
Order of lending benchmarks: BPLR, Base Rate (2010), MCLR (2016), external benchmark (2019).
Sources
- Reserve Bank of India — Interest Rate on Advances Directions (MCLR), 17 December 2015
- Reserve Bank of India — External Benchmark Based Lending circular (4 September 2019)