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What is the repo rate and how does it impact your loan's interest rates?

By Finserv MARKETS - Nov 29,2019
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What is the repo rate and how does it impact loan's interest rates

The Reserve Bank of India, from time to time, announces its monetary policy in order to control the money supply and the cost of taking credit. Through such measures, it can keep a tab on inflation, consumption, growth or liquidity- depending on the current macroeconomic scenario. Essentially, it aims to achieve goals like curbing inflation, increasing cash-flow, increasing investment, etc. One of these measures is the RBI repo rate. Since February this year, the RBI has slashed its repo rate 5 times. This can have widespread effects, mainly on your personal loan, home loan, and other loans. Let’s understand how this happens.

What is repo rate or repurchase rate?

The major source of income for banks is loans. Now, banks don’t give out loans just based on the strength of the deposits that we keep with them. They also borrow money from the Reserve Bank. The RBI charges an interest when it lends money to these banks, and the rate of this interest is called repo rate or repurchase rate. Hypothetically, if repo rate is 5 percent, and a bank receives a loan of Rs 1000 from the RBI, it will pay an interest of Rs 50 to the Reserve Bank. So, higher the repo rate, the greater the cost of short-term finance, and vice versa. The current RBI repo rate is 5.15%.

What is the reverse repo rate?

Just like banks borrow additional funds from the RBI, they also deposit their surplus funds with the RBI for a short period. There is a specific rate of interest that they earn from the RBI on these deposits, which is called the reverse repo rate.

What are CRR, MCLR, and SLR and why are they important?

CRR or Cash Reserve Ratio is the percentage of deposited money that the bank has to deposit with the RBI. If RBI cuts down CRR, it will mean banks will have more money to lend/invest. The current CRR is 4% p.a.

Banks are required to invest a certain percentage of their deposits in specific financial securities like government securities. This investment, as opposed to the CRR, earns them an interest. The current SLR is 18.75% p.a.

The marginal cost of funds-based lending rate (MCLR) is the minimum interest rate that a bank can lend at. The bank cannot charge any interest lower than this rate. The rate is determined internally by the bank depending on the period left for the repayment of a loan. The current MCLR fixed by the RBI stands between 8% and 8.40%.

Impact of cut in Repo Rate/SLR/CRR

What is the repo rate and how does it impact loan's interest rates

Source: Business Today

What are basis points?

You must have often come across the term ‘basis points’ while reading about monetary policies. One hundred basis points are equal to 1%. If RBI repo rate is 8.75% and the RBI increases it by 25 bps, then the new rate will be 9% as 25 bps are equal to 0.25%

How does repo rate affect your loan interest rate in theory?

The RBI has cut repo rate 5 times since February 2019. One of the reasons has been the poor predictions by international agencies for our GDP growth. The aim of the RBI has been to increase the flow of money in the economy, as it expects banks to pass on the cut in interest rate to customers. This, in theory, should encourage investment and demand.

How is repo rate actually affecting loan interest rates currently?

Despite repo rate being at a 9-year low, banks haven’t reduced their interest rates by a significant margin. Why is this happening? Because repo rates have a very small share in a bank’s overall funds, and it is simply not feasible for them to reduce it drastically. Almost 80% of their funds come from deposits by customers. To have a significant decrease in their loan interest rates, they need to reduce their deposit interest rates.

What is transmission and why is it weak?

Transmission is the passing on of changes in the RBI repo rate to customers of loans such as personal loan and home loan. Currently, the transmission is weak as banks are not willing to decrease their deposit rates due to fear of competition.

What is the repo rate and how does it impact loan's interest rates

Why are existing loan rates going up?

In an effort to reduce interest rates for new loans, banks are increasing the rates on existing loans and trying to gain financial flexibility. Remember that the fluctuations in interest rates affect only floating loans and not fixed loans. If you are planning to take a new loan, you can check out Bajaj Finserv Personal Loan available on Finserv MARKETS. You can easily avail a personal loan of upto Rs. 25 lakhs with zero collateral.

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When will repo rate practically affect my loan rate?

Whether it is a personal loan, home loan, vehicle loan, or any other loan, it will surely take more time and greater measures by the RBI for repo rate transmission to be significant. But since the RBI is expected to continue its accommodative stance, rates are only expected to go down in the near future, which makes this a good time to take a loan. If you will be opting for one, you can consider the loans available on Finserv MARKETS that come with a variety of benefits, including speedy disbursals and lightning fast approvals.

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