Definition
Marginal Cost of Funds
Marginal cost of funds is the cost of raising the next rupee of funds, used by the RBI's MCLR framework as the basis for pricing floating-rate bank loans.
Under the MCLR regime introduced in 2016, banks must price loans off their marginal cost of funds rather than the older average-cost-based base rate. The marginal cost reflects the latest deposit and borrowing rates, plus the negative carry on the CRR and operating costs.
Because it captures fresh funding costs, the marginal cost transmits RBI rate changes faster than the average cost. However, for retail and MSME loans the RBI later mandated external benchmarks like the repo rate (RLLR), which transmit even more directly than MCLR.
Related terms
- Cost of FundsCost of Funds is the weighted-average interest rate a bank or NBFC pays to raise the money it lends, covering deposits, borrowings and bonds.
- MCLR (Marginal Cost of Funds Lending Rate)MCLR is an internal benchmark that determines the minimum interest rate at which a bank can lend, based on its cost of funds.
- Repo-Linked Lending Rate (RLLR)RLLR is a lending rate tied directly to the RBI's repo rate, so changes in the repo rate quickly flow through to borrowers.
- CRR (Cash Reserve Ratio)The CRR is the share of a bank's deposits it must park as cash reserves with the RBI, earning no interest, which the RBI adjusts to control liquidity in the banking system.
Plain-English explainer from The Dispatch Investors Encyclopedia. General information, not financial advice.