Economy
Mint Explainer | RBI's rate cut and how it will benefit retail borrowers
Summary
- With RBI cutting repo rate, retail borrowers who have taken floating rate loans will see their EMIs shrink as banks pass on the benefit of rate to end consumers
Mumbai: The Reserve Bank of India’s (RBI) monetary policy committee on Friday delivered a much-anticipated rate cut of 25 basis points, taking the policy repo rate to 6.25%. The first rate cut in five years, the Monetary Policy Committee's decision will lead to lower equated monthly instalments or EMIs by retail borrowers by an equivalent amount, provided their rates are linked to the repo. Repo rate is the interest rate at which commercial banks borrow from the RBI.
Mint takes a look at what this means for thousands of retail borrowers.
How will RBI's rate cut lead to changes in interest rates for borrowers?
At present, retail and small business loans are linked to external benchmarks, and corporate loans are still on the marginal cost of fund-based lending rate or MCLR. EBLR refers to external benchmark-based lending rate, which, as the name suggests, is linked to benchmarks like the RBI repo rate and is used to price loans.
As of September 2024, over 59% of all floating rate loans were linked to an external benchmark, while 37% were linked to MCLR. A change in repo rate, therefore, translates to an equivalent change in the external benchmark rates of banks.
What will happen to monthly repayments for retail borrowers?
Meant to induce seamless transmission of rate changes by the central bank to bank lending rates, external benchmarks have in the past allowed retail borrowers to benefit when RBI was on a rate-cutting spree after the covid-19 pandemic.
This is going to be repeated this time round as well. Retail borrowers who have taken floating rate loans will see their EMIs shrink as banks pass on the benefit of lower repo rate to end consumers. Borrowers would also have the option to keep their EMIs constant while reducing their tenure over which they need to repay the loan.
How does this help credit growth?
A repo rate cut is also expected to lead to higher credit growth. As per latest data from the Reserve Bank of India, non-food credit growth stood at 11.4% in January. Non-food credit is bank credit after adjusting for loans given to the Food Corporation of India (FCI). A cautionary stance and a clampdown on unsecured loans has meant that banks have also gone slow on lending without collateral.
In fact, the aggregate growth of retail loans — home loans, credit card outstanding, education loan, vehicle loans, among others – has slowed down to 12% y-o-y in December 2024, as compared to 28.4% in the same period last year, as per RBI data. Other personal loans (consumption loans) witnessed a growth of 9.2% in December 2024, as against 23.2% in December 2023.
How long will it take for banks to pass on the rate cut to borrowers?
Under RBI norms, lenders need to reset their external benchmark based lending rate at least once in three months. This would mean that borrowers will able to get the benefit of lower interest rate once the lender resets the benchmark rate.
Will RBI’s rate cut impact lenders?
Experts believe that the rate cut may hit banks' net interest margin, which is a key indicator of profitability. Estimates by rating agency Icra showed that on an aggregate level bank margins will contract by 15 basis points (bps).
Sachin Sachdeva, vice-president, sector head, financial sector ratings, Icra said the impact on private lenders is expected to be higher at 21 bps of net interest margin. For public sector banks, the margins are expected to contract 11 bps. The impact will be higher for private banks because of their higher share of EBLR loans than public sector banks, said Sachdeva.
Also Read: On interest rates, RBI should ‘cross the river by feeling the stones’
