Reserve Bank of India’s (RBI) bi-monthly monetary policy of June 7, 2016 was a disappointment for many seeking reduction in their home loan equated monthly instalments (EMIs). However, there is something to cheer about. You may still see your borrowing costs come down if Raghuram Rajan, Governor, RBI has his way.

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In December last year, RBI had announced that all banks will have to follow a new and uniform methodology to calculate base rate as per the ‘marginal cost of funds’. This new method has come in effect from April 1, 2016.

That time, according to a PTI report, RBI had said, "The guidelines are also expected to ensure availability of bank credit at interest rates which are fair to the borrowers as well as the banks."

Since then the term "MCLR" has been used frequently by RBI in its monetary policy reviews.

What is Marginal Cost of Funds based Lending Rate (MCLR)?

MCLR is the new lending regime which was set up by RBI to faster the monetary policy rates transmission from banks to borrowers. In simple words, RBI has brought down its repo rate from 8.75% to 6.5% since January 2015 but banks’ lending rates have fallen only 30 basis points.

One reason is because till March, banks used base rate as the benchmark to lend, but from April 1, MCLR was the new benchmark for new borrowers. 

RBI had said, "Apart from helping improve the transmission of policy rates into the lending rates of banks, these measures are expected to improve transparency in the methodology followed by banks for determining interest rates on advances".

This year, in April, RBI Governor Raghuram Rajan had announced the rates cut by 25 basis points (bps). But even after two months, the average lending rate has come down only by 30-35 bps.

One basis point is one-hundredth of a percentage.

RBI had asked banks to move to the new lending rate regime to ensure they pass on the benefits of RBI's rate cuts to their customers at a faster pace. 

During the monetary policy review meet on June 7, Rajan said, "Transmission of policy into bank lending rates still remains work in progress. We will shortly review the operation of the marginal cost lending rate framework to iron out any issues."