As central banks across the world announced rate cuts to stave off a COVID-19-related recession, the Reserve Bank Of India (RBI) cut the repo rate and reserve repo rate by 75 basis points and 90 bps, respectively. The repo rate refers to the rate at which commercial banks borrow money by selling their securities to the Central bank of India. The repo rate now stands at 4.4 percent and reserve repo rate at 4 percent. The monetary policy review of the RBI was rescheduled amidst the pandemic which was originally scheduled to take place on March 31, 2020, and April 3, 2020. The Repo Rate cuts had an influence on the lending rate or rate of interest on mortgages like personal loans, marriage loans, etc. This reduction in the rate of interest is expected to increase the demand for loans. A reduction in the Cash Reserve Ratio (CRR) would enhance the availability of funds and bring in more liquidity to the banking system. The Cash Reserve Ratio is a specified small part of the total deposits of customers, which commercial banks have to hold as reserves with the central bank.
This will alternately affect the economy as well, which is one of the reasons why RBI introduces such a change. However, it is important to note that the repo rate cut would lead to a reduction in the rate of interest only if the loan has been offered on a floating interest rate basis. On the other hand, if a personal loan has been offered on a fixed interest rate basis, then the interest rates would not be affected by any changes in the repo rate. Therefore, repo rate cuts will benefit new personal loan borrowers when the banks implement the changes but existing borrowers who have opted for the fixed rate of interest would not benefit from the same.
Rate cuts impact on loan borrowers
The following shows the impact of the rate cut for different types of loan borrowers.
For existing loan borrowers
- With loans linked to an external benchmark
Personal loan borrowers whose loans are linked with an external benchmark. i.e., the repo rate, treasury-bills etc. as mandated by the RBI can expect to see their EMIs go down in the next three months. Therefore, the RBIs rate cut will lower a borrower’s EMI outgo in the next three months. This is the second time RBI has cut the repo rate after the new lending rate regime came into effect from October 1, 2019.
- With loans linked to MCLR
Borrowers whose loans are linked to the marginal cost-based lending rate (MCLR) will benefit only when their bank reduces loan rates. This is because MCLR is dependent on not just external factors such as rate cut but also on the internal factors of the bank. Further, the reduction in MCLR will translate into lower EMIs only when the reset date of your home loan arrives. Usually, a bank offers home loans with a reset period of six months or one year. On the reset date, your future EMIs will be calculated on the basis of the rate of interest prevailing on that date. Recently, SBI reduced the MCLR by up to 15 bps with effect from March 10, 2020.
If the borrower wants to switch from an MCLR-based loan to an external benchmark one, then you can do this by paying an administrative cost. However, it is advisable to make a switch only if the interest rate difference between the two is 0.50 percent or more.
- With loans linked to the base rate or BPLR
Borrowers whose home loan is still linked to the base rate or Benchmark Prime Lending Rate (BPLR) should consider switching to an external benchmark based loan. The new external benchmark loan regime offers better transmission of policy rates, compared to the base rate and BPLR rate-linked loans.
New loan borrowers
The recent RBI repo rate cut will make taking new loans cheaper for borrowers. While availing a loan linked to an external benchmark, do compare the spread and risk premium charged by the banks over and above the external benchmark, to get the cheapest interest rate on loans. With a reduction in lending rates, personal loans will become more affordable for borrowers. However, it is also essential to have a moderate transmission in the rate of growth of credit. Otherwise, the overall effect of the repo rate cut will stay neutral.
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