Business Loan Interest Rates in India: How MCLR, EBLR and Spreads Work
Most floating rate bank loans to businesses are priced as a benchmark plus a spread. New floating rate bank loans to MSMEs must use an external benchmark, usually the repo rate, reset at least every three months. Older loans may use the bank's MCLR and NBFCs price on their own policy, so compare offers on the KFS APR.
What makes up your interest rate?
Interest rate = Benchmark + Spread
- Benchmark: a reference rate that moves with the market, such as the RBI repo rate (for EBLR) or the bank's own MCLR.
- Spread: the lender's margin over the benchmark. It reflects your credit risk, the security, the product and the lender's costs.
When the benchmark moves, your rate moves at the next reset. When your credit profile changes, the spread may change under the terms of your loan.
What is MCLR?
MCLR, the Marginal Cost of Funds based Lending Rate, applies to bank loans sanctioned from April 1, 2016 that are not on an external benchmark. Each bank sets its MCLR from its own marginal cost of funds, operating costs and other factors, and publishes MCLRs for tenors such as overnight, one month, three months, six months and one year. Your loan is linked to one MCLR tenor, and the reset period matches that tenor, for example yearly for a one-year MCLR.
Because MCLR reflects the bank's own cost of funds, it responds to RBI policy changes with a lag.
What is EBLR?
EBLR, the External Benchmark based Lending Rate, links your rate to a benchmark outside the bank. RBI required banks to link all new floating rate loans to micro and small enterprises (and personal and retail loans) to an external benchmark from October 1, 2019. An amendment of February 26, 2020 extended this to medium enterprises from April 1, 2020.
The permitted benchmarks are:
- RBI's policy repo rate.
- Government of India 3-month or 6-month Treasury bill yield published by FBIL.
- Any other benchmark market interest rate published by FBIL.
The rate must be reset at least once every three months. Most banks use the repo rate. EBLR passes on RBI rate changes faster than MCLR.
Can the bank change your spread?
Under RBI's Interest Rate on Advances Directions, banks are free to set the spread over an external benchmark, but with limits once the loan is running:
- The credit risk premium may change only when your credit assessment changes substantially, as agreed in the loan contract.
- Other spread components, including operating cost, may be altered once in three years. Under an amendment now in the Directions, banks may reduce these components earlier for a loan category for customer retention, on justifiable grounds and in a non-discriminatory way.
So a cut in the repo rate flows through at the next reset, while a change in your spread needs a trigger in the contract. Read the spread clause in your sanction letter.
How do MCLR and EBLR compare?
| Factor | MCLR | EBLR |
|---|---|---|
| Benchmark | Bank's internal cost of funds | External, usually repo rate |
| Applies to | Bank loans from April 2016 not on EBLR | New floating rate retail and MSME loans from October 2019 (MSE) and April 2020 (medium) |
| Reset frequency | Matches the linked MCLR tenor | At least once in three months |
| Transmission of RBI rate changes | Slower | Faster |
| Transparency | Bank-specific | Benchmark is public |
Do NBFCs use MCLR or EBLR?
No. MCLR and EBLR rules apply to banks. NBFCs set rates under a board-approved interest rate model and must disclose their approach, but they are not tied to these benchmarks. Many NBFC loans are linked to the NBFC's own reference rate. Read the sanction letter to see what your rate is linked to.
Worked example: a repo rate change on an EBLR loan
Illustrative numbers. The rates are assumed for the arithmetic only and are not market quotes.
| Item | Before | After a 0.25% repo cut |
|---|---|---|
| Repo rate (assumed) | 5.50% | 5.25% |
| Spread | 3.50% | 3.50% |
| Loan rate | 9.00% | 8.75% |
| Annual interest on ₹2 crore term loan outstanding | ₹18 lakh | ₹17.5 lakh |
The saving is ₹50,000 a year on this balance, effective from the next reset date. On a cash credit, the saving applies to the average balance used.
What is APR and why does it matter?
APR, the annual percentage rate, is the all-in annual cost of the loan, including interest and fees. Under RBI's April 15, 2024 circular, regulated lenders must give a Key Facts Statement (KFS) for retail and MSME term loans, including the APR and a repayment schedule. This became mandatory for new loans from October 1, 2024. Charges not listed in the KFS cannot be levied without your explicit consent.
Worked example: comparing on APR
Illustrative. Two offers for a ₹1 crore three-year term loan.
| Item | Offer A | Offer B |
|---|---|---|
| Interest rate | 9.50% | 9.25% |
| Processing fee | 0.50% | 1.50% |
| Other upfront fees | ₹10,000 | ₹40,000 |
Offer B has the lower rate but higher fees. On a three-year loan, the extra ₹1.3 lakh of upfront fees outweighs the interest saved by a 0.25% lower rate, which is roughly ₹40,000 over the life of an amortising loan. The APR in each KFS will show which is cheaper. Always compare APRs, not headline rates.
What are penal charges?
Since RBI's August 18, 2023 circular, regulated lenders charge penal charges, not penal interest, for defaults or non-compliance. Penal charges cannot be added to the interest rate or capitalised, and must be reasonable and disclosed in the loan agreement and KFS. The rules applied to fresh loans from April 1, 2024, and to existing loans from the next review or renewal date or June 30, 2024, whichever was earlier.
What can you do to get a better rate?
- Improve your credit profile: clean repayment history, lower leverage and a stronger DSCR.
- Offer better security: a secured loan against property usually prices below unsecured credit.
- Match the product to the need: use invoice discounting for receivables and working capital limits for operating cycles, not long-term loans for short-term needs.
- Ask about spread review when your credit rating or financials improve materially.
- Compare APRs across lender types. See bank vs NBFC vs private credit.
- Check prepayment terms. For floating rate business loans to individuals and MSEs sanctioned or renewed from January 1, 2026, many regulated lenders cannot charge prepayment fees.
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