Big setback for borrowers, home, auto, personal loans set to get costly; RBI to blame

Over two policies now, India has seen a rise of 50 basis points in policy repo rate, with latest hike made today by RBI in the third bi-monthly monetary policy for FY19. Now policy repo rate stands at 6.50% from previous 6.25%. With this, India’s policy repo rate has reached a two year high because the last time when 6.50% mark was achieved was in 2016 April policy. Why you should be worried about repo rate hike is because this is not good news for banks, which means it is a bad sign for you as well. The repo rate is linked to your home, auto and personal loans, in other words retail loans of lenders. 

Repo rate is a rate at which banks borrow money from the RBI in case they have shortage of funds. RBI decides to hike repo rate in order to control money supply, level of inflation and liquidity in the country. 

From June - July 2018, the systematic liquidity remained in surplus mode.  Systemic liquidity moved back into surplus mode in early July with increased government spending but turned into deficit from July 10 onwards; on a daily net average basis, the Reserve Bank injected liquidity under the LAF of Rs 107 billion in July. 

When there is high level inflation which is currently at 5% in India, the central bank’s attempt is to reduce the money supply of economy. Thereby, looking at the surplus in liquidity this does call for a rate hike. 

What basically RBI does is increase the repo rate, makes it costly for lender to borrow money, which in return will slow down investment and then as an aftermath will result in downward trend in liquidity in the economy. Although the growth of economy gets impacted at certain level, but this definitely helps in taking inflation down. 

Now how does this bother you! It’s very simple, repo rate has a direct impact on cost of borrowing of funds for banks. The higher the repo rate, the higher will be cost of borrowing and vice versa. 

This is not something that any bank will like. 

If banks get impacted...

Each lending and deposit rates decided by any bank has a direct relationship with policy repo rate. 

When banks borrow funds from the central bank during shortage, they will now pay higher interest rate which is 6.50% this was not the case two policy ago as they just paid 6% till June 2018. So now with a 50 basis points hike borrowing from RBI becomes costly for banks. 

Repo is referred as repurchase option, which comes as a contract provided by a bank to RBI for availing overnight loans by giving eligible securities like Treasury Bills with a commitment that they will purchase the security back at a predetermined price. Hence, the interest rate charged on this repo transaction is called as repo rate. 

Although the higher repo rate may not have an immediate impact on banks and hence your loan. Banks usually opt for loan from RBI after analysing their liquidity position and cost of funds before increasing the deposit rates and lending rates. 

If there is a need of funds, then banks will begin in passing their repo rate burden on you by raising lending rates. It needs to be noted that, home loans and other floating rate loans are the ones which get highly impacted when RBI hikes repo rate. 

Loans are the major income for banks, and higher lending rates would slow down business of banking system which will impact their earnings in book. 

Other option to save themselves from RBI’s repo rate, would be hike in deposit rates so that customers find it attractive to make investment with them. 

A hike in deposit rate has already begun. Just few days before of RBI’s policy, largest state-owned lender SBI already made between 5 basis point to 10 basis point hike in fixed deposits, other can follow the same now that RBI has also hiked rate. 

You get impacted... 

As discussed, if banks get impacted by borrowing from RBI at higher repo rate, this discourages them from availing short-term loans and advances from the apex bank. 

Therefore, due to non-availability of low cost funds banks will have no other option but to hike lending rates for customer in order to pass the burden. 

Such will in return decrease the consumer purchasing power. 

The impact of this 6.50% repo rate would be more painful for new loan borrowers, as the existing one can continue to pay their EMIs on the existing lending rates. 

What can you do? 

If you are a newcomer in any kind of loan like home, auto or personal, then make sure to compare the interest rate offered by various lenders in order to take a final call. You should remember, interest rate varies from bank to bank. 

In case you are existing borrower and have linked your loan with MCLR, then when the reset date of your loan arrives, you will feel the burden of new repo rate, as your future EMI’s will be derived based on the MCLR for that date. Avoid having a reset date on your loan, make sure that you repay your loan within time-period. 

And if your loan is linked with base rate and BPLR, then switch it to MCLR as it has better transparency and transmission of policy prices. 

If you cannot pay higher EMIs, try getting loan under Pradhan Mantri Awas Yojana which is credit linked interest subsidy sanctioned as per your income level. 

Hence, if you feel your facing heavy loan burden, make sure to go through the above mentioned guidelines.