Pause in policy rates

How it’s going to benefit borrowers
Pause in policy rates
Representational PictureFile/ GK

With economy continuing in pandemic-induced quandary, the Reserve Bank of India (RBI) in its bi-monthly monetary policy review meeting on August 6, 2021, maintained status quo on policy rates yet again. It’s eighth consecutive time that the apex bank has not flirted with the policy rates and kept the key rates unchanged. The repo rate continues to remain at 4%, while the reverse rate stands unchanged at 3.35%. It was in May 2020 when the RBI reduced the repo rate to 4% and is the lowest since April 2001.

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. The repo rate also refers to the interest rate, which borrowers pay to the banks, when they take loan from them.

Any change in the repo rate has a direct bearing on the borrowers as their loans carry floating rate of interest. This means, if the repo rate is increased, the rate of interest on loans is bound to go up and borrowers have to shell out increased EMI (equated monthly installment). A cut in repo rate means lower rate of interest on loans.

There’s a common belief that this kind of a rate cut is always good for common borrowers and businesses. The perceived wisdom is that it will re-ignite a sputtering economy.

Since this kind of rate cut infuses liquidity in the market and the banks and other financial institutions will have more cash in hand to lend, it triggers boost in investment scenario as it increases the banking system’s potential by expanding more loans in a profitable manner.

Now, the status quo on rates means that the banks will most likely not increase interest rates on loans, at least in near future.

Before deliberating upon the status quo on the policy rates and its impact on common consumers, it is worth mentioning that over a period of time, fast financial intermediation even into unreached areas of domestic affairs of a common man has changed the economics of thinking preferences of one and all. In this major shift in thinking process, common people now keenly follow stance of monetary policy whenever the Reserve Bank of India (RBI) announces it.

Surprisingly, people today know more about percentages of cash reserve ratio (CRR), Repo & Reverse Repo rates than the prices of essential commodities. And let me tell you, this fast financial intermediation through loan products almost for all population segments has changed. Today, equated monthly installments (EMIs) have become integral part of most of our lives.

Even as transmission of cut in policy rates to the borrowers was a major concern as banks would either ignore or delay the benefit of the low rates to the customers, it witnessed improvement since the introduction of external benchmark-based pricing of loans. Remarkably, it was from October 2019, when the RBI mandated banks to link all new floating rate personal, and micro and small enterprises (MSEs) loans to an external benchmark, like the policy repo rate or three-month or six-month treasury-bill rate or any other benchmark market interest rate published by Financial Benchmarks India Private Ltd (FBIL). Then, since April 2020, loans to medium enterprises have also been linked to an external benchmark.

It’s also worth mentioning that during this year, the RBI reduced the key policy rate thrice with an aggregate reduction of 0.75 percentage point in the repo rate. According to the RBI governor, Shaktikanta Das, one positive thing that is happening now is, earlier it used to take six months for transmission, and now the transmission is taking a much shorter period of 2-3 months.

What will be the impact of status quo on repo rate on borrowers?

The RBI’s decision to keep key policy rates unchanged reflects the continuation of its accommodative stance ensuring the lowest lending rates to keep business operational across sectors. In other words, the loans, particularly the home loans, car loans or cash loans will continue to be affordable.

Is this rate pause going to help the new and existing borrowers in home loan segment?

Yes. If we talk of the housing segment, continuation of the low interest rate scenario will boost the home buying sentiment and propel its growth. Remarkably, the decadal low-interest rates have already helped sustain homebuyers’ interest in the residential segment, and positively impacting the overall demand over the last two quarters.

Borrowers in the home loan segment are definitely at an advantage. Home loans have a long term repayment schedule and any change in the rate of interest considerably impacts the overall interest payment during the remaining period of the loan. With repo rate being at the lowest level seen in the last two decades, a pause in the repo rate continuation of the low interest rate regime augurs well for the new borrower looking for a home loan.
As far as existing borrowers are concerned, there would be no change in their EMIs. However, they need to cross-check with their banks if their loans are linked to the external benchmark rate or any other rate. If your bank may is charging higher interest rate on your home loan than what is being charged on the repo-rate linked home loan, then ask your bank to switch your loan to repo-rate linked interest rate regime. Notably, some banks charge a nominal switching fee.
Banks charge higher rate of interest on personal loans and often change it, mostly upwards. Is the status quo in policy rates lending some relief to these loans?

As already stated, the current interest regime with repo rate at its lowest in two decades has made the loans cheaper. The market conditions reflect that the banks are unlikely to increase rates in personal loans any time soon. However, those planning to take route of personal loan to fund their needs should ensure healthy credit score. A good credit score can help them to get a loan at a good interest rate.

However, those who have availed the personal loan and are repaying it through fixed EMIs won’t get any relief in rate of interest. However, they can look for switching the loan to some other bank if they are offered lower rate than what they are paying. Switching a personal loan to low interest regime can save money if done in the middle of the repayment schedule. This is the period when the major component in the EMI is loaded with the interest amount and switching can help the borrower to save interest amount.

How the pause in repo rate is going to help auto loans?

If expert opinions are to be believed, the low interest rate regime is not going to stay for long. This means the current pause in policy rates is not permanent and can witness upward trend in coming times. So, this is the best time for those who are planning a loan to purchase a vehicle of their choice. This time they can enjoy the lower EMI payments as the interest rate is decadal low.

It is worth mentioning that vehicle loans carry fixed rate of interest and doesn’t change during the entire tenure of the loan. This means taking a vehicle in the current low interest regime will be advantageous as the borrower will pay lower EMIs during the entire repayment period.

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