Loan framework: RBI proposes new MCLR formula based on 3-month moving average of funding costs

The Reserve Bank of India (RBI) has proposed changes to the way banks calculate their Marginal Cost of Funds Based Lending Rate (MCLR), suggesting that the marginal cost of funds should be determined using a moving average of the marginal costs of domestic deposits and borrowings over the preceding three months.

The proposal is part of a broader draft framework aimed at bringing greater consistency and transparency to the way lenders determine interest rates on loans. The proposed rules cover fixed and floating-rate loans, benchmark-linked lending, spreads, rate resets and the treatment of existing loans.

Under the proposed methodology, banks would calculate MCLR using the marginal cost of domestic deposits and borrowings during the trailing three-month period. For each month, banks would use an annualised weighted average interest cost based on the volume of new deposits and borrowings.

The RBI has proposed that this data should be system-generated and independently verifiable, a move that could bring greater standardisation to the calculation of banks’ funding costs.

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How the proposed MCLR calculation will work

The proposed framework seeks to link the marginal cost component more closely with the actual cost at which banks raise fresh funds. Instead of relying on a single point-in-time assessment, the three-month moving average would capture funding costs over a longer period.

The RBI’s draft specifies that the calculation should take into account the marginal costs of domestic deposits and borrowings. The weighted average interest cost for each month would be based on the volume of new deposits and borrowings during that period.

This methodology is intended to make the calculation more transparent and reduce scope for variations in how individual lenders determine their marginal funding costs.

MCLR forms an important part of the interest-rate framework for loans linked to the benchmark. Changes in a bank’s marginal funding costs can therefore influence the lending rates applicable to borrowers whose loans are linked to MCLR.

Part of wider loan pricing overhaul

The proposed MCLR changes come alongside several other measures aimed at standardising loan pricing. The RBI has proposed that floating-rate loans should be linked to an internal or external benchmark plus a risk-based spread.

For most floating-rate loans, the benchmark reset period would not exceed three months. Once a reset frequency is selected, it generally cannot be changed during the tenor of the loan.

The draft also proposes greater discipline around spreads. The spread would comprise a credit risk premium and one or more components such as operating cost, term premium and business strategy premium. While these components may be positive or zero, the credit risk premium would have to remain positive.

The RBI has further proposed that the credit risk premium should be revised only when there is a change in the borrower’s credit profile, in accordance with the lender’s policy and loan agreement.

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New framework proposed from April 2027

The proposed framework is expected to take effect from April 1, 2027, subject to finalisation following stakeholder feedback.

The RBI has also proposed that existing loans linked to internal or external benchmarks be migrated to the prescribed interest-rate framework by April 1, 2029, through a one-time mapping exercise.

The broader objective of the draft is to make loan pricing more transparent and consistent across lenders while giving borrowers greater clarity on how their interest rates are determined and revised.