RBI’s New MCLR Formula: 3-Month Funding Average

The Reserve Bank of India (RBI) has put forward a proposal to introduce a new formula for calculating the Marginal Cost of Funds-based Lending Rate (MCLR). This significant change aims to link the MCLR directly to banks’ funding costs, specifically through a 3-month moving average.

Understanding the Proposed Mechanism

Under the new framework, the MCLR, which determines the minimum interest rate banks can charge borrowers, will be derived from a consistent average of the costs incurred by banks to raise funds. This approach intends to provide a more stable and representative benchmark for lending rates.

• The formula will track the actual cost of funds for banks over a specified period.
• Instead of instantaneous costs, a smoothed average will be used to mitigate volatility.
• This new calculation directly influences the base rate for various loan products.

How the 3-Month Moving Average Operates

A 3-month moving average involves continuously calculating the average of a data set over the most recent three months. Each month, the oldest data point is dropped, and the newest one is added, creating a ‘moving’ window of data.

• The funding costs for the current month and the two preceding months are aggregated.
• This sum is then divided by three to yield the average for that specific period.
• This methodology helps to smooth out any sharp, short-term fluctuations in funding costs, offering a more stable rate.

This proposed shift by the RBI aims to ensure that lending rates reflect a more consistent and averaged view of the true cost of funds for financial institutions. The change focuses purely on the structural calculation of the MCLR itself.