As the Reserve Bank of India (RBI) started reducing interest rates early this year, with a bonus 50-basis point cut in the recent June monetary policy, borrowers have had something to cheer about as they now have lower EMIs to service.
However, even as you plan for lower monthly outflows on your loans, there is another key aspect to note on interest rates.
Banks and NBFCs offer loans — mostly on floating interest — based on different internal and external rate benchmarks. Broadly, these are of two types. Marginal cost of lending rate (MCLR)-based loans are based on internal benchmarks and metrics of the lending institutions. External benchmark-based lending rate (EBLR) and the widely-used RLLR (repo-linked lending rate) are other options. In a way, RLLR is a subset of EBLR.
Making a choice between these options is not easy. They differ on aspects such as how the rates themselves are determined, the frequency of their reset and their response to the RBI rate-cuts, among other factors. Understanding these rates is the key to taking the decision on going with either MCLR or RLLR.
Internal benchmark
The concept of MCLR goes back to the year 2016. The RBI mandated a new regime to transition from a base rate lending concept.
Now, the MCLR is determined by banks and NBFCs based on multiple factors. The first is the marginal cost of funds, which is dependent on the rate of borrowings, deposit rates, return on net worth, among a few other parameters.
Then there are operating costs of the bank associated with salaries, administrative expenses, rents etc.
The third factor is the tenor premium. Usually, the longer the tenor of the loan, the higher would be the interest rate, as perceived risks increase with rising repayment periods.
Finally, there are also opportunity losses on regulatory requirements such as CRR (cash reserve ratio). The cost of keeping the mandated CRR with the RBI without earning any interest is calculated. It is referred to as the negative carry on CRR.
All these factors are combined to arrive at the final MCLR of a lending institution.
The lower the borrowing costs, deposit rates and operating costs of a bank, the lower would be the MCLR. Large banks that operate at huge scale are likely to have lower MCLR than smaller banks or institutions.
When the RBI increases/decreases interest rates or tweaks regulatory requirements, some components of the MCLR change (borrowing, lending costs, carry on CRR etc), but with a lag. Operating expenses etc do not change immediately. Overall, since the costs internal to a bank cannot change at quick notice, MCLR rates are tweaked at a relatively slower pace.
Typically, MCLR loans transmit the full quantum of interest rates over six months to one year.
For example, SBI has kept its one-year MCLR unchanged at 9 per cent since November 2024, even though repo rate has been reduced by 100 basis points this year.
During rate hikes, too, MCLR loans do not immediately increase rates, but do so in stages. This gives borrowers a bit more time to adjust their cash flows and shore up their finances.
From May 2022 to February 2023, the RBI increased the repo rate by 250 basis points. But SBI’s one-year MCLR increased only by 140 basis points.
The loan agreement based on MCLR would specify the exact frequency of interest rate reset and exceptions, if any.
Repo holds the key
In 2019, the RBI mandated external benchmarking for determining loan interest rates. Thus, the repo-linked lending rates were operationalised by banks and NBFCs.
As the name itself indicates, RLLR-based loans benchmark themselves to the repo rate decided by the RBI from time to time.
Since repo is external to the bank, it is deemed to be an external benchmark.
Therefore, any increase or decrease in the repo rate will have a direct impact on the borrowing rate.
Typically, the rates in RLLR-based loans are passed on to borrowers within a maximum of three months. However, that doesn’t mean you get loans at the repo rate.
Every lending institution has its own credit risk premium based on its own profile, and this is a mark-up added to the repo rate to determine the interest rate.
The credit risk premium can range from 2.5-3.5 per cent or higher.
RLLR loans are advantageous when interest rates fall as the transmission happens quickly, thus giving relief on EMIs to borrowers.
But during repo rate hikes, you would be forced to cough up higher EMIs or extend the tenor of the loan, thus affecting your cash flows and overall financial plans – especially during a period like May 2022 to February 2023 that we mentioned earlier.
You can switch from MCLR loans to the RLLR regime by paying a fee, which differs based on individual banks and NBFCs, if you find it advantageous in terms of cost savings.
Both MCLR and RLLR have their advantages and shortcomings.
If your total EMI (personal, home, auto or any other debt) is only a modest portion of your salary (20-25 per cent), and a quick rise in rates isn’t likely to significantly eat into your surplus, RLLR loans may be better at the margins.
Those preferring relative stability and a slower pace of EMI increases, especially during rising interest rates, can consider going with MCLR loans.
Published on June 21, 2025