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Q43 (IAS/2016) Economy › Money, Banking & Inflation › Interest rate concepts Official Key

What is/are the purpose/purposes of the 'Marginal Cost of Funds based Lending Rate (MCLR)' announced by RBI? 1. These guidelines help improve the transparency in the methodology followed by banks for determining the interest rates on advances. 2. These guidelines help ensure availability of bank credit at interest rates which are fair to the borrowers as well as the banks. Select the correct answer using the code given below.

Result
Your answer: —  ·  Correct: C
Explanation

The correct answer is option C because both statements accurately reflect the purposes of MCLR as announced by RBI.

MCLR helps improve the transparency in the methodology followed by banks for determining the lending rates.[1] This directly validates statement 1, which refers to interest rates on advances (lending).

The MCLR methodology helps ensure availability of bank credit at interest rates which are fair to the borrowers as well as banks.[1] This confirms statement 2 is correct.

RBI introduced the MCLR methodology for fixing interest rates from 1 April 2016, replacing the base rate structure, which had been in place since July 2010.[2] The MCLR system was designed to address shortcomings in the earlier base rate system by linking lending rates to the marginal cost of funds, thereby enabling fast transmission of repo rate into lending rate (better monetary policy transmission).[1]

Since both statements 1 and 2 correctly describe the purposes of MCLR, option C (Both 1 and 2) is the correct answer.

Sources
  1. [1] Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 91
  2. [2] Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > INCREMENTAL CASH RESERVE RATIO > p. 169
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Q. What is/are the purpose/purposes of the 'Marginal Cost of Funds based Lending Rate (MCLR)' announced by RBI? 1. These guidelines help im…
At a glance
Origin: From standard books Fairness: High fairness Books / CA: 10/10 · 0/10

This is a classic 'Policy Objective' question. When RBI introduces a new acronym (MCLR, EBLR, ICRR), the official stated rationale is the first thing to memorize. Standard economy texts copy-paste these objectives directly from RBI notifications. If you read the 'Why' behind the reform, this is a free hit.

How this question is built

This question can be broken into the following sub-statements. Tap a statement sentence to jump into its detailed analysis.

Statement 1
Was increasing transparency in banks' methodology for determining interest rates on advances stated as an objective of the Reserve Bank of India's Marginal Cost of Funds based Lending Rate (MCLR) introduced in 2016?
Origin: Direct from books Fairness: Straightforward Book-answerable
From standard books
Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 91
Presence: 5/5
“Hence, because of linking the lending rate with marginal cost of deposits, there will be fast transmission of repo rate into lending rate (better monetary policy transmission). It will also help improve the transparency in the methodology followed by banks for determining the lending rates. The MCLR methodology will help ensure availability of bank credit at interest rates which are fair to the borrowers as well as banks. Every Bank calculates its own MCLR rate based on cost of deposits, operational costs, reserve requirements and tenor premium. So MCLR (or Base Rate) is an "internal benchmark" which varies from bank to bank.”
Why this source?
  • Explicitly states MCLR 'will also help improve the transparency in the methodology followed by banks for determining the lending rates.'
  • Directly links the MCLR methodology to the objective of improving transparency of lending-rate determination.
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > INCREMENTAL CASH RESERVE RATIO > p. 169
Presence: 4/5
“However, based on recommendations of Narasimham Committee on banking sector reforms, the rate of SLR was gradually reduced. Rate of SLR as on 5 February 2021 stood at 18 per cent of NDTL. MCLR - The Marginal Cost of funds-based Lending Rate (MCLR) is the minimum interest rate below which a bank cannot lend. RBI introduced the MCLR methodology for fixing interest rates from 1 April 2016, replacing the base rate structure, which had been in place since July 2010.”
Why this source?
  • Confirms RBI introduced the MCLR methodology from 1 April 2016, replacing the previous base rate structure.
  • Provides temporal context showing the timing when those objectives (like transparency) became relevant.
Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Base Rate: > p. 90
Presence: 3/5
“Base Rate was introduced in July 2010 replacing the Benchmark Prime Lending Rate (BPLR) system. Base Rate is the minimum rate below which Scheduled Commercial Banks cannot lend. RBI publishes guidelines for calculation of Base Rate and every bank calculates its own base rate. Base rate calculation methodology was based on the following four factors: • (Average) Cost of deposits/funds (interest rate that bank offers to its depositors)• Cost of maintaining CRR and SLR (if the banks are required to keep higher reserves like CRR and SLR, then they will be able to lend less money & will have to charge higher interest rate)• Operational Costs of Banks• Return/profit on Net worth (investment) From 1st April 2016, RBI introduced a new methodology for calculation of the Base Rates based on marginal cost of funds rather than average cost of funds.”
Why this source?
  • Describes the methodological shift in 2016 from average-cost (base rate) to marginal-cost (MCLR) calculation.
  • Supports that MCLR was a change in methodology — consistent with objectives such as making rate-setting more transparent.
Statement 2
Was ensuring availability of bank credit at interest rates fair to both borrowers and banks stated as an objective of the Reserve Bank of India's Marginal Cost of Funds based Lending Rate (MCLR) introduced in 2016?
Origin: Direct from books Fairness: Straightforward Book-answerable
From standard books
Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 91
Presence: 5/5
“Hence, because of linking the lending rate with marginal cost of deposits, there will be fast transmission of repo rate into lending rate (better monetary policy transmission). It will also help improve the transparency in the methodology followed by banks for determining the lending rates. The MCLR methodology will help ensure availability of bank credit at interest rates which are fair to the borrowers as well as banks. Every Bank calculates its own MCLR rate based on cost of deposits, operational costs, reserve requirements and tenor premium. So MCLR (or Base Rate) is an "internal benchmark" which varies from bank to bank.”
Why this source?
  • Directly states the MCLR methodology will help ensure availability of bank credit at interest rates fair to borrowers as well as banks.
  • Also links MCLR to improved transparency and faster transmission of policy rates into lending rates, reinforcing the stated objective.
Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > INCREMENTAL CASH RESERVE RATIO > p. 169
Presence: 4/5
“However, based on recommendations of Narasimham Committee on banking sector reforms, the rate of SLR was gradually reduced. Rate of SLR as on 5 February 2021 stood at 18 per cent of NDTL. MCLR - The Marginal Cost of funds-based Lending Rate (MCLR) is the minimum interest rate below which a bank cannot lend. RBI introduced the MCLR methodology for fixing interest rates from 1 April 2016, replacing the base rate structure, which had been in place since July 2010.”
Why this source?
  • Confirms RBI introduced the MCLR methodology on 1 April 2016, establishing the policy context referenced in the statement.
  • Identifies MCLR as the methodology for fixing interest rates, supporting that the objective is tied to the 2016 introduction.
Pattern takeaway: UPSC focuses on the 'Philosophical Intent' of economic reforms rather than the mathematical derivation. They want to know if you understand *why* the RBI moved from Base Rate to MCLR (to improve transmission and transparency), not how to calculate the basis points.
How you should have studied
  1. [THE VERDICT]: Sitter. Directly lifted from standard Economy textbooks (Vivek Singh/Singhania) under the 'Banking Reforms' or 'Monetary Policy' chapter.
  2. [THE CONCEPTUAL TRIGGER]: Monetary Policy Transmission. The evolution of lending rate benchmarks: BPLR → Base Rate → MCLR → EBLR.
  3. [THE HORIZONTAL EXPANSION]: Memorize the timeline and key flaw of each: BPLR (Opaque/Sub-BPLR lending) → Base Rate (Average Cost/Slow transmission) → MCLR (Marginal Cost/Faster but still lagged) → EBLR (External Benchmark/Immediate transmission). Key MCLR components: Marginal cost of funds, Negative carry on CRR, Operating costs, Tenor premium.
  4. [THE STRATEGIC METACOGNITION]: Don't just memorize the formula; understand the 'Bureaucratic Intent'. The keywords 'Transparency' and 'Fairness' are the standard justifications for almost every RBI reform. If a policy replaces an old one, its primary goal is invariably to fix opacity or inefficiency.
Concept hooks from this question
📌 Adjacent topic to master
S1
👉 MCLR — stated objectives (transparency & fairness)
💡 The insight

References explicitly describe MCLR's aim to improve transparency in banks' lending-rate methodology and to ensure fair rates.

High-yield for UPSC: questions often ask policy objectives of RBI reforms. Understanding MCLR's stated goals lets candidates answer directly and link to borrower/bank fairness and regulation. Prepare by memorising key objectives and examples of policy language; connect to broader banking reform themes.

📚 Reading List :
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 91
  • Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > INCREMENTAL CASH RESERVE RATIO > p. 169
🔗 Anchor: "Was increasing transparency in banks' methodology for determining interest rates..."
📌 Adjacent topic to master
S1
👉 Marginal cost versus average cost methodology (MCLR vs Base Rate)
💡 The insight

Sources note the 2016 shift from base rate (average-cost) to MCLR (marginal-cost) methodology for lending-rate calculation.

Frequently tested in banking/monetary policy questions — helps explain why RBI changed the benchmark and its implications for transmission and rate-setting. Useful for comparative questions and for explaining transmission mechanics; study by comparing formulae, pros/cons, and timeline.

📚 Reading List :
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Base Rate: > p. 90
  • Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > INCREMENTAL CASH RESERVE RATIO > p. 169
🔗 Anchor: "Was increasing transparency in banks' methodology for determining interest rates..."
📌 Adjacent topic to master
S1
👉 Monetary policy transmission & anchor-rate linkage
💡 The insight

Evidence links MCLR to faster repo-rate transmission and mentions mandates to link lending rates to an anchor like MCLR.

Important for essays and mains answers connecting RBI policy tools to transmission to the economy. Master how benchmark choices affect speed of transmission, loan repricing, and borrower impact; use examples (MCLR, external benchmarks) to illustrate.

📚 Reading List :
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 91
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 92
🔗 Anchor: "Was increasing transparency in banks' methodology for determining interest rates..."
📌 Adjacent topic to master
S2
👉 Objectives of MCLR: fairness, transparency, transmission
💡 The insight

Reference [1] explicitly lists ensuring fair interest rates for borrowers and banks, improved transparency, and faster repo-to-lending rate transmission as MCLR goals.

High-yield for UPSC: questions often ask objectives and intended effects of RBI policy changes. Mastering these objectives helps answer policy-impact and evaluation questions, and to compare MCLR with previous regimes (base rate). Prepare by memorizing objectives and practicing application to case-style questions about monetary transmission and borrower impact.

📚 Reading List :
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 91
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.19 Base Rate, MCLR and External Benchmark Rate > p. 89
🔗 Anchor: "Was ensuring availability of bank credit at interest rates fair to both borrower..."
📌 Adjacent topic to master
S2
👉 MCLR replaced Base Rate on 1 April 2016
💡 The insight

References [3] and [4] state RBI introduced MCLR from 1 April 2016, replacing the earlier base rate system.

Dates and replacements of major policy frameworks are frequently tested; knowing when MCLR replaced base rate and why (marginal vs average cost) helps in mains answers and prelims MCQs. Revise timelines and contrast features of base rate vs MCLR, using tabular notes for quick recall.

📚 Reading List :
  • Indian Economy, Nitin Singhania .(ed 2nd 2021-22) > Chapter 7: Money and Banking > INCREMENTAL CASH RESERVE RATIO > p. 169
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > Base Rate: > p. 90
🔗 Anchor: "Was ensuring availability of bank credit at interest rates fair to both borrower..."
📌 Adjacent topic to master
S2
👉 Linking lending rates to marginal cost / anchor rates
💡 The insight

References [5] and [7] discuss RBI's mandate to link lending to an anchor (like MCLR) and explain marginal cost of funds concept (cost of deposits) that underpins MCLR.

Understanding how anchor rates and marginal cost drive lending-rate transmission is crucial for questions on monetary policy transmission, bank behaviour, and borrower impact. Practice by tracing how repo rate changes flow through MCLR to borrowers and comparing with external-benchmark linkage.

📚 Reading List :
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > MCLR > p. 92
  • Indian Economy, Vivek Singh (7th ed. 2023-24) > Chapter 2: Money and Banking- Part I > 2.19 Base Rate, MCLR and External Benchmark Rate > p. 89
🔗 Anchor: "Was ensuring availability of bank credit at interest rates fair to both borrower..."
🌑 The Hidden Trap

The 'Components of MCLR' are the logical sibling fact often found on the same page. These are: 1) Marginal cost of funds (comprising Marginal cost of borrowings and Return on net worth), 2) Negative carry on account of CRR, 3) Operating costs, and 4) Tenor premium. Note that 'Spread' is added over MCLR to determine the final rate.

⚡ Elimination Cheat Code

The 'Good Governance' Heuristic. In questions about government or RBI guidelines, statements that describe broad, positive, non-extreme objectives like 'improving transparency,' 'ensuring fairness,' or 'increasing accountability' are almost always Correct. These are the default goals of public policy. Unless the statement implies a technical impossibility, mark it true.

🔗 Mains Connection

GS-3 (Investment Models & Growth): Efficient monetary transmission is the bridge between RBI Policy and GDP Growth. If MCLR fails to pass on rate cuts, the 'Investment Cycle' stalls. This connects to the 'Twin Balance Sheet' problem and the need for EBLR (External Benchmark) to force banks to pass benefits to consumers.

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