The Reserve Bank of India formulates, implements, and regulates the monetary policy of India. The main objective of the monetary policy of the RBI is to regulate the currency and credit system in India. And to ensure the smooth functioning of the fiscal policies, RBI uses several financial instruments like bank rate, the repo rate, reserve repo rate, etc. All the tools used by the RBI are revised every quarter, based on various macroeconomic factors. Both the repo rate and MCLR play an important role in controlling the flow of cash in the system.
What is Repo Rate?
The commercial banks of India borrow short term loans from the Reserve Bank of India when they go through a financial crunch. The interest rate at which the RBI gives loan to commercial banks is the repo rate. To avail the short term loan, the banks have to provide RBI-recognised securities like Treasury Bill to the RBI and repurchase them after a given period.
What is MCLR?
MCLR refers to the Marginal Cost of Funds Based Lending Rate. RBI implemented it on 1st April 2016 to replace the previously used base rate system. An internal benchmark rate, the MCLR is the rate below which the banks cannot lend money. The banks are required to revise the MCLR according to the changes in the repo rate made by the RBI.
Difference Between Repo Rate and MCLR
Though both the repo rate and MCLR have a direct link and both work for the same aim, there are some differences between repo rate and MCLR. The changes in the repo rate affect the MCLR and, therefore, directly affects it. Some differences between the repo rate and MCLR are:
- The changes in the repo rate are made by the RBI either to increase the flow of cash in the system or to bring down the liquidity in the market. On the other hand, the changes in the MCLR is made by the commercial banks according to the revision of the repo rate. If the repo rate increases, the banks increase the MCLR and vice versa.
- MCLR determines the lowest interest rate the commercial banks and other financial organizations advance loans. Therefore, the revision in the MCLR only affects the people who avail a loan. But, any changes in the repo rate affects all the areas of the economy. Some sectors gain from the revised rates, while some suffer loss.
- The repo rate is increased by the RBI when the inflation hits the nation. Increasing the repo rate helps to lower the flow of cash in the system. In the same way, the RBI decreases the repo rate when it wants to reduce the amount of cash in the system. But, MCLR is calculated by the banks based on various factors like the amount of time a person takes to repay the loan, the marginal cost of fund, operational expenses, etc.
- The repo rate is an external factor that controls the credit supply in the market. And being an external factor affects various financial transactions in the economy. On the other hand, MCLR is internal affects the fee charged in loans.
The Reserve Bank of India revises the repo rate, and this makes the banks to revise their MCLR proportionately. Lowering of the repo rate makes home loans and car loans cheaper because the banks lower the MCLR. It encourages people to avail a loan. While a hike in the repo rate will increase the MCLR, and availing loan will become a costly affair. In this way, in spite of the differences, the repo rate and the MCLR controls the credit supply in the Indian economy.
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