When it comes to the world of finance, there are several key terms that one must understand in order to make informed decisions. Two such terms are “Repo Rate” and “MCLR Rate.” While these terms may seem similar at first glance, they actually refer to very different things. In this post, we will take a closer look to understand how Repo Rate is different from MCLR Rate:
What is Repo Rate?
Repo Rate stands for “Repurchase Rate,” and is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks. The RBI uses Repo Rate as a tool to control inflation, as well as to manage liquidity in the banking system.
When banks need money, they can borrow from the RBI at the current Repo Rate. This borrowing is done through a process known as a “repurchase agreement,” or “repo.” In a repo, the bank sells security (usually government bonds) to the RBI, with an agreement to buy it back at a later date at a slightly higher price. This difference in price represents the interest charged by the RBI.
Changes in the Repo Rate can have a ripple effect throughout the economy. When the RBI raises the Repo Rate, borrowing becomes more expensive for commercial banks. This can cause banks to increase their lending rates, making loans more expensive for consumers and businesses. Conversely, when the RBI lowers the Repo Rate, borrowing becomes cheaper for commercial banks, which can lead to lower lending rates for consumers and businesses.
What is MCLR Rate?
MCLR stands for “Marginal Cost of Funds Based Lending Rate.” Unlike Repo Rate, which is set by the RBI, MCLR is set by individual banks. MCLR is the minimum interest rate that a bank can charge on loans to its customers, and is based on the bank’s marginal cost of funds.
In simple terms, the marginal cost of funds is the cost that a bank incurs for each additional rupee that it lends. This includes the cost of borrowing from other banks, as well as the cost of deposits from customers. By calculating its marginal cost of funds, a bank can set its MCLR, which determines the interest rate that it charges on loans to customers.
Like the Repo Rate, changes in MCLR can have an impact on borrowing and lending rates. When a bank raises its MCLR, it becomes more expensive for customers to borrow money from that bank. This can cause customers to seek out loans from other banks with lower MCLRs. Conversely, when a bank lowers its MCLR, it can become more competitive in the lending market, attracting more customers and potentially increasing its profits.
Key Differences Between Repo Rate and MCLR Rate
Now that we understand what Repo Rate and MCLR Rate are, let’s take a closer look at some of the key differences between them:
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Who sets the rate?
The most obvious difference between Repo Rate and MCLR Rate is who sets the rate. As we’ve already discussed, Repo Rate is set by the RBI, while MCLR is set by individual banks.
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What the rate is used for?
Repo Rate is used by the RBI to control inflation and manage liquidity in the banking system. MCLR, on the other hand, is used by banks to determine the interest rates that they charge on loans to customers.
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How often it changes?
Repo Rate can change at any time, depending on the RBI’s assessment of economic conditions. MCLR, on the other hand, typically changes on a monthly basis, as banks recalculate their marginal cost of funds.
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Impact on borrowers?
While both Repo Rate and MCLR can impact borrowing and lending rates, the impact of the Repo Rate is more indirect. Changes in Repo Rates can cause commercial banks to adjust their lending rates, which can ultimately impact borrowers. On the other hand, MCLR directly affects the interest rates that individual banks charge on loans to their customers.
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Transparency
Repo Rate is set by the RBI and is a transparent process, as changes in the rate are announced and published. MCLR, however, is determined by individual banks, and the calculation of the marginal cost of funds may not be completely transparent.
Relationship between the two:
There is a relationship between Repo Rate and MCLR, as changes in Repo Rate can influence MCLR. When the RBI raises Repo Rate, it becomes more expensive for banks to borrow money, which can lead to an increase in MCLR. Conversely, when the RBI lowers Repo Rate, banks can borrow money more cheaply, potentially leading to a decrease in MCLR.
Which one should borrowers pay more attention to?
As a borrower, it’s important to understand both Repo Rate and MCLR, as they can both have an impact on the interest rate that you’ll pay on a loan. However, MCLR is likely to be more relevant to individual borrowers, as it directly determines the interest rate that their bank will charge on a loan. On the other hand, changes in Repo Rate are more likely to have an indirect impact on borrowing rates.
It’s also important to note that MCLR can vary from bank to bank, so it’s a good idea to compare the current home loan MCLR rates of different banks before taking out a loan. Borrowers should also be aware that MCLR rates can change over time, so it’s important to monitor changes and be prepared for potential fluctuations in borrowing rates.
Conclusion
If you are planning on taking out a loan, it’s important to shop around and compare the MCLR rates offered by different banks. Additionally, keep an eye on changes in the Repo Rate, as these can also affect lending rates over time. By staying informed and making well-researched decisions, you can ensure that you are getting the best possible deal on your loans, while also understanding the broader economic context in which you are operating.