Your EMIs won't fall so soon, but lock into fixed deposits

  • Deposit and lending rates may go down, but only gradually and not in proportion to the reduction in repo rate
  • If you are an existing borrower and want to switch to a lender that offers a lower rate, do a cost-benefit analysis

Mumbai: In the first bimonthly review of the monetary policy in the new financial year, the Monetary Policy Committee of the Reserve Bank of India (RBI) on Thursday decided to cut the benchmark repo rate by 25 basis points (bps) to 6%. The rate cut was widely expected after the 25 bps cut in the repo rate in February from 6.50% to 6.25%. One bps is one-hundredth of a percentage point.

Depositors and borrowers are among those who watch the policy rates keenly as they do give a direction to deposit and lending rates, though the transmission is not proportionate and is gradual.

Deposit rates may go down

If you are a depositor, a falling interest rate means you will get lower returns from new deposits. Remember that fixed or term deposits booked at a higher rate in the past continue to give higher returns till the time of maturity.

With the cut in repo rate, banks are expected to reduce fixed deposit rates in the coming days. However, the reduction may not be proportionate to the cut in repo rate. This is due to the fact that credit growth in the economy in the past year has been higher than the growth in deposits. Banks need more deposits to be able to raise funds that they can lend. Accordingly, the reduction in deposit rates might not be proportional to the repo rate cut.

Shanti Ekambaram, president, consumer banking, Kotak Mahindra Bank Ltd, said deposit rates will go down in the next few months, though it will not be easy for banks to move deposits (downwards) because deposit growth is slower than credit growth. “Small savings rates are also very high. The provident fund rate has also gone up. So banks have to fight alternative avenues for deposits. The entire equation of transmission will be determined by deposit growth and how much banks can keep reducing their deposit rates going forward. Transmission will happen over the next few months. How the deposit rates reduction happens is key for how even the loan rates transmission happens in the future," she said.

EMIs won’t reduce Immediately

With RBI cutting the benchmark repo rate by 50 bps since February 2019, retail consumers will expect a reduction in their EMIs on various loans, especially home loans. However, the impact in EMIs would not be visible soon. “No substantial relief is expected for borrowers in their monthly loan instalments as banks are unlikely to induce a large cut in their benchmark lending rates," said Anil Gupta, sector head of financial sector ratings at Icra Ltd.

There are two reasons for this. The first is that floating rate retail loans like home loans are based on the marginal cost of lending rate (MCLR), which never goes down in proportion to the repo rate cut. This is because a bank’s cost of funds also includes deposit rates, which are not dropping proportionately either. That is why after the 25 bps repo rate cut in February, some leading banks reduced loan rates by a marginal 5-10 bps.

Banks revisit their MCLR each month. As per RBI, the one-year median MCLR has declined by just 5 bps since the February rate cut, while the median term deposit rate across maturities of banks declined by 3 bps. “After the last cut, we have seen banks reduce their MCLR across tenures and some amount of transmission has happened and this will continue. Banks were not able to reduce deposit rates too much, possibly because it was the last quarter of the financial year. Ultimately the transmission by banks will depend upon their cost of funds," Ekambaram said.

The second reason is that your MCLR-linked home loan has a reset date, and a new rate comes into effect from this date. Typically, this reset happens once a year. So even if banks reduce the MCLR, the effect will be visible in your loan only from your next reset date. For instance, if you have a home loan based on on-year MCLR and the reset date falls in January, you will see an impact in your interest rates only in January next year, even if the bank reduces the MCLR in response to the rate cut.

External benchmarks

RBI had in December 2018 announced that all floating rate retail loans would be benchmarked to an external benchmark like the repo rate or treasury bills yield from 1 April 2019. While the final guidelines were awaited, RBI said on Thursday that it had decided to hold further consultations with stakeholders to “work out an effective mechanism for transmission of rates". In the post policy press conference, RBI governor Shaktikanta Das did not specify a timeline for the same.

Gupta said that the resolution to defer the decision to link lending rates on smaller loans to external benchmarks was expected to improve transparency for borrowers, even though it would have created challenges for the banks, given the liabilities for Indian banks are largely fixed rate in nature. “In our view, increased depositor education to improve their acceptability of floating rate deposits needs to done first before moving on to external benchmarking of loans and mitigate the interest rate risks for the banks" he said.

As a consumer, external benchmarking of retail loans would be an ideal situation for transmission of rate changes by RBI.

If you are an existing borrower and want to switch to a lender that offers a lower rate, do a cost-benefit analysis to determine if the switch will benefit you at all (see graphic). Borrowers looking to take a new loan should try to get it from leading public sector banks, even if it involves a tedious process.