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Marginal Cost of Funds based Lending Rate (MCLR) is a new methodology by the RBI for setting the lending rate by commercial banks. It has replaced the existing base rate system w.e.f April 2016. 
Marginal Cost of Funds based Lending Rate (MCLR) will be the internal benchmark lending rates set by the banks as per the new guidelines by the RBI. On the basis of MCLR, the rate of interest for different types of customers should be fixed according to the risk involved. The base rate will be determined on the basis of the calculation of MCLR. The rate of interest given by a bank for deposits and the repo rate (obtaining funds from the RBI) are the decisive factors in the calculation of MCLR. Hence, the MCLR should be revised on a month-by-month basis while considering factors like repo rate and other borrowing rates that had not been considered under the base rate system.
Calculation of MCLR 
The word marginal means “additional” or “changed”. In the calculation of lending rate, banks have to take into consideration the “changed” or “marginal” cost conditions. For banks, the cost of obtaining funds is the interest rate given to the depositors (referred as “cost for the funds”), Hence, “Marginal Cost of Funds based Lending Rate” meaning, change in interest rates lent to depositors. 
The MCLR norm describes different components of marginal costs. A unique factor in the calculation of lending rate is the incorporation of “the repo rate” i.e. interest rate given to the RBI for getting short term funds.
Following are the main components of MCLR:
1. Marginal cost of funds: The marginal cost that is the novel element of the MCLR. The marginal cost of funds will comprise of Marginal cost of borrowings and return on net-worth.  According to the RBI, the Marginal Cost should be charged on the basis of following factors:

Interest rate given for various types of deposits – savings, current, term deposit, foreign currency deposit
Borrowings – Short term interest rate or the Repo rate etc., Long term rupee borrowing rate
Return on net-worth – in accordance with capital adequacy norms

    2.    Negative carry on account of CRR: is the cost that the banks have to incur while keeping reserves with the RBI. The RBI does not give an interest for CRR held by the banks. The cost of such funds kept idle can be charged from loans given to the people.
3. Operating costs: is the operating expenses incurred by the banks
4. Tenor premium: denotes that higher interest can be charged from long term loans

How MCLR is different from base rate?
The base rate or the standard lending rate by a bank is calculated on the basis of the following factors:
1. Cost of funds (Rate of Interest given to depositors)
2. Operating expenses
3. Minimum rate of return 
4. Cost for the CRR (for the 4% CRR)
But the most important difference is the careful calculation of Marginal costs under MCLR. On the other hand under base rate, the cost is calculated on an average basis by simply averaging the interest rate incurred for deposits. The requirement that MCLR should be revised monthly makes the MCLR very dynamic compared to the base rate.

Reason MCLR has been introduced

Before April 2016, the banks were slightly slow to change their interest rate in accordance with repo rate change by the RBI. Commercial banks had been significantly depending upon the RBI’s LAF repo to get short term funds. But they had been reluctant to change their individual lending rates and deposit rates with periodic changes in repo rate.
Whenever the RBI was changing the repo rate, it was verbally compelling banks to make changes in their lending rate. The purpose of changing the repo was realised only when the banks were changing their individual lending and deposit rates.

Benefits of MCLR 

1. Costs that the bank is incurring to get funds (means deposit) is calculated on a marginal basis
2. The marginal costs include Repo rate; whereas this was not included under the base rate.
3. Many other interest rates usually incurred by banks when mobilizing funds also to be carefully considered by banks when calculating the costs.
4. The MCLR should be revised monthly.
5. A tenor premium or higher interest rate for long term loans should be included.L