Explained: Repo rate’s effect on Personal loan interest

Repo-rate

Over the last few months, there has been talk about the new repo rates in the banking and finance industry and its impact on the lending market. The term “repo rate” is short for “repurchase rate”. It is the rate at which a country’s central bank lends money to commercial banks in case of a funds shortage. In India, the Reserve Bank of India (RBI) provides credit to commercial banks against collateral. The repo rate also used by the government to control inflation.

 

As a borrower looking for a  personal loan in Bangalore, it’s useful to understand what the repo rate is all about, which we’ll explain below.

RBI-repo rate for banking
RBI-repo rate for banking

How Repo Rate Works

Basically, during inflation, central banks will increase the repo rate to discourage commercial banks to borrow from the central bank. As a result, this reduces both the amount of cash in circulation as well as inflation. In the event that inflation reduces significantly, the central bank will take a contrary measure and introduce reverse repo rates, so as to increase liquidity and circulation of money in the economy.

 

For example, let’s suppose the current repo rate is 5% and a bank takes a loan of Rs 1 lakh from the RBI. The interest owed by the bank would be Rs. 5,000. Therefore, the lower the repo rate, the lower the interest rate levied on loans taken from commercial banks by individuals.

 

In June 2019, it announced that it will be cutting repo rates for banks, lenders and individuals by 25 points. This brings the current repo rate to 5.75% from the earlier rate of 6%. The reverse repo rate has also lowered to 5.75% from 6%. A reduction in the repo rate lowers the borrowing cost for both commercial banks and lenders.

 

When repo rate is reduced, the interest rate on loans are also reduced; this in turn also lowers the Cash Reserve Ratio (CRR) which increases the amount of credit available to individuals. The reduction in the interest rate done in the expectancy of increasing consumer demand for these products.

How Repo Rate Will Affect Borrowers

In such a situation, expected that lenders will pass on the rate cut to their borrowers. Therefore, if you have previously availed loans on a floating interest rate, your EMI will probably reduce. While it is expected that the lowered repo rate reduces the interest rate levied by lenders, the actual change in interest rate depends on a variety of things, such as the lender’s operational costs, among other factors. Therefore, if you are considering taking out a personal loan, you may benefit from the RBI’s recent cut in interest rates.

However, one should note that a cut in the repo rate only leads to a cut in the interest rate of a loan, if it has been provided on the basis of a floating interest rate. If a personal loan availed on a fixed rate of interest, then the interest rate will remain unaffected by any change in the repo rate. Thus, the new repo rate cut will only benefit borrowers when banks implement the reduced rate.

On the other hand, when the RBI increases the repo rates, commercial banks required to pay more for the cost of credit borrowed from the RBI. As a result, these banks increase the interest on the loans the offer to borrowers.

The cut in repo rates will also drastically reduce the cost of borrowing for borrowers, thus, making personal loans more affordable. The lower interest rates will also highly benefit borrowers looking to avail personal loan in Bangalore.

bank repo rate impact
bank repo rate impact

Repo Rate Effect on Loan EMI

As per the circular released by RBI, the interest rate linked to any external benchmark must reset at least once every three months. This means banks will now need to reprice interest rates on loans at least once every three months and pass on any change in the external benchmark rate.

Let’s say that a borrower avails a loan on July 15, with a rest period of 3 months. Suppose in September’s monetary policy review, the RBI slashes the repo rate by 25 points. As per the new rate system, in this case, the borrower will not receive the instant benefit of the rate reduction, as the interest on their loan will only be revised in November on the reset date. However, if the repo rate reduced again in November, the borrower can avail of the benefit of both rate cuts.

However, if the reset date has been fixed for 2 months instead of 3 months, the borrower will eligible for a 25 point rate cut from October onwards, based on the repo rate cut that occurred in September’s monetary policy review.

 

 

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