Interest rates set to rise
BANK WATCH BY SAJJAD BAZAZ
For protecting its net margin, a bank typically counters a rise in the reverse repo rate by increasing its lending rates on housing loans, car loans, personal loans, and other retail loans.
OVER a period of few years, we have seen that people here are showing inclination towards financial literacy. Or we can say that they have become more conscious about various aspects of financial solutions – be it saving money for future needs or taking loans to meet their urgent requirements. Whenever the Reserve Bank of India touches Cash Reserve Ratio (CRR), Repo rate or Reverse Repo rate, an individual alarmingly begins to analyze the impact of any such change in these rates.
A few days back Reserve Bank of India (RBI) announced a pre-mature rate hike just a month before the next policy meeting scheduled on April 20. The apex bank hiked the repo and reverse repo rates by 25 bps on March 19 after the close of the market hours. And this move surprised everyone, including the banking fraternity. With this latest round of rate hikes in the key short-term lending and borrowing rates, the repo rates currently stand at 5% and reverse repo rates at 3.5%, the apex bank has signaled the banking fraternity towards hardening of lending rates in order to combat rising inflation.
Notably, following the global recession pinching the global economy, RBI had adopted a softer stance on the front of interest rate regime starting from December 2008. During this time RBI had slashed its repo rate by 0.5% and reverse repo rate by 1% from the then month ago figures of November 2008. But with the news of sharp recession in the US and other western economies being confirmed around the time of January 2009, RBI had moved on further to sharply reduce the repo rate by 1% and reverse repo rate to 4%, down 1% from the month of December 2008.
With the latest round of rate hike announced yesterday, one can say that the rate cycle on downside has peaked and has started moving in the opposite direction. The RBI has hiked lending and borrowing rates for the first time since global recession.
What is repo and reverse repo? Repo is the rate at which RBI lends to banks and reverse repo is the rate of interest RBI pays to the banks on their deposits. When the central bank feels that there is excess money in the system, it hikes repo rates in order to stiffen rates and supply of money from its side as a lender body. A rise in the reverse repo rate is normally undertaken to cool an overheating market (to cut down the element of speculation in the market) or when the inflation rate shows signs of a sharp rise. So these rates form a crucial tool for RBI in managing the monetary policy and flow of funds in the financial system.
Now, what does this hike means to a common man? The answer to this question is not good news for a common man. Hike in these rates could lead to hike in the interest rates on personal loans, like home loans, car loans etc.
A rise in the reverse repo rate raises the cost of borrowing funds of the banks, leading to a rise in lending as well deposit rates to negate the effect. For protecting its net margin, a bank typically counters a rise in the reverse repo rate by increasing its lending rates on housing loans, car loans, personal loans, and other retail loans. Ultimately, the weight of a higher interest rate regime is borne by the consumer.
We have witnessed that every time the RBI has made an upward revision in its reverse repo rate, the country’s leading scheduled banks providing home loans and car loans have countered with an increase in their lending rates. Notably, interest rates on car loans have even witnessed a surge of at least 3.0 percent points since December 2005 due to hike in these rates.
The frequent changes in interest rates have thrown a big challenge to the banking fraternity, as far as their customer relationship management is concerned. We have observed that such changes, particularly when there is hike in interest rates, have led to disputes when a borrower challenges the hike in his EMI (equated monthly installment). Basically most of the customers are not financially literate and hardly understand how the aspects of financial market are linked with the surge in interest rates. So banks have only one viable medium to avoid this confronting situation and that is making their customers financially literate. More the financial literacy among customers, more healthy will be the banker-customer relationship.
In a state like ours, financial literacy is a concern and this has led to more confronting attitude of customers at bank branches. In fact the need for financial literacy is even greater considering the low levels of literacy and the large section of the population, which still remains out of the formal financial set-up. Everyone saves money for future needs but the approach is to save surplus money without preparing household budgets, without prioritising personal financial goals, without properly allocating investments in different asset classes and without understanding the real rate of return.
But what is this financial literacy? Web definition of the financial literacy defines it as the ability to understand finance. More specifically, it refers to an individual's ability to make informed judgments and effective decisions about the use and management of their money.
In simpler terms, financial literacy primarily relates to personal finance, which enables individuals to take effective action to improve overall well-being and avoid distress in financial matters. It goes beyond the provision of financial information and advice. In fact it is the ability to know, monitor, and effectively use financial resources to enhance the well-being and economic security of oneself, one’s family, and one’s business.
Why do we need financial literacy? A person makes a wide array of financial decisions through his lifetime. Examples of such decisions include providing for children’s higher education, saving for retirement, managing credit wisely, tax and estate planning, insurance, etc. These decisions are driven by the emergence of a need. So here it is the financial education which is very important to help the persons to make informed decisions.
More precisely, financial literacy plays a significant role in the efficient allocation of household savings and the ability of a person to meet his financial goals. We all know that financial markets have become increasingly complex and the common man finds it very difficult to make informed decisions. And the answer to this complex situation is financial literacy. Once an individual becomes literate in financial markets, he ensures financial stability for himself on all fronts.
So, financial literacy campaign will go a long way not only to help individuals in making healthy financial decisions for financial stability, but this will also help the banks to smoothen their relationship with their customers.
(The views are of the author & not the institution he works for. Feedback: firstname.lastname@example.org)
Lastupdate on : Wed, 24 Mar 2010 21:30:00 Makkah time
Lastupdate on : Wed, 24 Mar 2010 18:30:00 GMT
Lastupdate on : Thu, 25 Mar 2010 00:00:00 IST
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