How do interest rate cuts impact you? Will loans get cheaper now?


Despite the cut in repo rate, no relief has been provided to home and auto loan borrowers. Not all bankers are looking at reducing their interest rate. Hence, there is less easing for loan EMIs

The Reserve Bank of India (RBI) cut the repo rate by just 0.25% to 7.25 on 3 May 2013 in its monetary policy for the fiscal 2013-14, and kept the cash reserve ratio (CRR) for banks unchanged at 4%. The move was aimed to provide relief to home and auto loan borrowers.

Repo is the rate at which the RBI lends money to banks. A reduction in the repo rate helps banks get money at a cheaper rate and vice versa. CRR is the amount of funds that the banks have to park with the RBI, which should not be less than 4%. If the central bank decides to increase the CRR, the available amount with the banks comes down. The RBI uses the CRR to drain out excess money from the system.

The repo rate also refers to the interest rate, which borrowers pay to the banks, when they take loan from them. The banks charges interest that is higher than the existing repo rate. Hence, lower repo rates could induce banks to lower their interest rates which they charge to their home or auto loan borrowers—thereby making loans more affordable.   

When the repo rate is raised, banks are compelled to pay higher interest to the RBI which in turn prompts them to raise the interest rates on loans they offer to customers. The RBI revises CRR and repo rates in their quarterly and mid-quarter policy reviews to maintain a balance between growth and inflation.

From April 2012 till April 2013, the central bank has cut the benchmark repo rate by 125 basis points to 1.25%. One basis point is equivalent to 0.01%. Despite the easing of repo rate or interest rate by RBI, the average lending rates of banks have declined by less than 0.5%, according to RBI data.

According to banks, to reduce lending rates, they should be in a position to cut deposit rates as well, which they may not be able to do at a time when the demand for deposits has been slow. 

Also, at present the statutory liquidity ratio (SLR) stands at 23%. SLR is the portion of deposits that banks are mandated to keep in government securities. SLR—fixed by RBI—refers to the amount that the banks require to maintain in the form of gold or government approved securities before providing credit to the customers. However, SLR deposits parked with RBI do not incur any interest for banks.

Despite the cut in repo rate, no relief has been provided to home and auto loan borrowers. Not all bankers are looking at a possible reduction in the interest rate. Hence, there is less easing for your home or auto loan EMIs.  

Also, the demand for home and auto loans continues to be strong; hence there is little scope for reduction in interest rate, according to the banks.

The lowering of rates has only benefitted the new borrowers and not the existing borrowers, including those who have taken home loan on floating interest rate. If old borrowers want to take advantage of the new rate, they will have to switch, for which they will have to pay 0.25% to 0.5% of the outstanding amount as a fees.

Currently, the new borrowers can borrow at around 10.25% per annum, while the old borrowers continue to pay 11% annually. Typically, existing borrowers are charged interest rates that are 50-100 bps higher than the rates offered to new borrowers.

While banks offer an option to existing borrowers to switch to the new rate, they are asked to pay a conversion charge of 0.5%-1%.

Many banks are charging old borrowers’ higher interest rate than new borrowers. Most old borrowers even are not aware of it. The old borrowers need to approach their banks and ask to for reduction in interest rate which they are offering to the new borrowers.

In the current situation, it is advisable to opt for floating rate loan. This is because there are no pre-payment penalties on floating rate loans, while banks continue to levy prepayment penalty on a fixed rate loan.


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