Repo-linked interest rates to benefit loan borrowers
4 min read.Updated: 04 Oct 2019, 11:27 PM ISTNeil Borate
For depositors, it may make sense to go for small savings schemes that are currently giving better rates than FDs
Existing borrowers should not rush to refinance their home loan to a new repo-linked product
Along expected lines, the Reserve Bank of India (RBI) on Friday cut the benchmark repo rate for the fifth consecutive time in this calendar. It cut the repo rate by 0.25% to 5.15% and remained committed to a broadly accommodative stance. The repo rate is the rate at which RBI lends money to banks. “The rate cut was necessary, given the widening negative output gap, weak growth impulses, global slowdown, benign inflationary pressure and weak monetary transmission," said Arun Singh, chief economist, Dun and Bradsheet India.
This latest rate cut takes the cumulative rate cuts in 2019 to 1.35%. In its “Statement on Developmental and Regulatory Policies" released alongside the rates decision, RBI also announced the creation of an internal ombudsman by large non-bank issuers of prepaid payment instruments issuers (such as MobiKwik or PhonePe). “This would bring about a swifter resolution of customer complaints and increase the confidence in digital transactions among users," said Adhil Shetty, CEO, BankBazaar.
Better transmission ahead
The current rate cut is likely to directly impact your home loan interest rate since RBI has made it mandatory for banks to link their lending rates to external benchmarks, such as the repo rate, for floating rate loans from 1 October. However, banks are allowed to charge a spread above the repo rate, which means the actual home loan rate is several percentage points higher than RBI’s repo rate.
In its statement on Friday, RBI expressed concern with respect to the transmission of rate cuts. “Monetary transmission has remained staggered and incomplete. As against the cumulative policy repo rate reduction of 110 bps during February-August 2019, the weighted average lending rate (WALR) on fresh rupee loans of commercial banks declined by 29 bps. However, WALR on outstanding rupee loans increased by 7 bps during the same period," it said. This ongoing concern was the primary reason why the central bank made it mandatory for banks to link their lending rates to an external benchmark.
Explicit linkage to an external benchmark is likely to improve transmission of the current and future rate cuts because, after the announcement, banks won’t be able to hike the spread in response to cuts in the benchmark rate. “The spread over the benchmark rate — to be decided wholly at banks’ discretion at the inception of the loan—should remain unchanged through the life of the loan, unless the borrower’s credit assessment undergoes a substantial change and as agreed upon in the loan contract," said RBI’s Statement on Developmental and Regulatory Policies in December 2018. Banks have already announced the spread they will charge over benchmark rates in response to RBI’s directives. “Most banks have launched loans linked to the repo rate. We expect transmission to take place over the next few months," said Shanti Ekambaram, president, consumer banking, Kotak Mahindra Bank.
However, there are a few caveats as well. “The new benchmark applies to new loans only, and loans of existing borrowers will continue the same way till their tenure. They can consider transferring their MCLR-linked or base rate-linked loans to a repo-linked loan. Loans taken from NBFCs and housing finance companies will see no change as these will not be linked to an external benchmark," said Shetty.
In addition, the benefit of repo rate linkage depends on future rate cuts and here experts sounded a cautious note."Borrowers should note that we are not very far from the bottom of the rate cycle. We expect at least another 25 basis points (0.25%) rate cut from here," said Ekambaram. Once the interest rate cycle reverses, the actual loan rates can go up.
Small savings over FDs
While a rate cut bodes well for borrowers, it creates a tougher environment for savers as fixed deposit (FD) rates would go down. Rates for small savings schemes such as Public Provident Fund (PPF) and Senior Citizens Savings Scheme (SCSS) were left unchanged for the third quarter (October-December 2019), making them more attractive to savers who otherwise prefer FDs. “Absolutely risk averse savers should look at small savings up to the maximum limits permitted," said Deepali, founder partner of Srujan Financial Advisers LLP.
The SCSS rate of 8.6% compares favourably with bank rates. For example, the highest rate offered by the State Bank of India to senior citizens is 7%, for a term of one year to less than two years. Savers who are not senior citizens can place their money in five-year National Savings Certificate (NSC), which offers 7.9%.
Existing borrowers should not rush to refinance their home loan to a new repo-linked product. It is unclear how many more rate cuts are in the pipeline. “Customers will have to pay some charges when switching from an MCLR product to a repo product. In SBI, this is 0.25% of your loan amount," said Gaurav Gupta, CEO, Myloancare.
On the savings side, depositors who are willing to stomach some illiquidity should consider moving some of their money to small savings instruments. For instance, instead of a five-year FD, you could contemplate investing in a five-year National Savings Certificates (NSCs), considering the current rates.