The RBI failed to ring in Christmas cheer, retaining its key policy repo rate at 5.15 per cent. Hugely disappointing markets that had factored in a 25-basis-point reduction, the RBI chose to pause after lowering the repo rate in quick succession five times in 2019.
So, what does this mean for borrowers and depositors?
Taking stock
The central bank has lowered its policy repo rate — the rate at which banks borrow short-term funds from the RBI — by 135 bps this year. But the weighted average lending rate on new loans (until October) has fallen by just 40-47 bps across private and public sector banks (PSBs). For existing borrowers, lending rates appear to have hardly moved. In fact, since January, the weighted average lending rate on outstanding loans has inched up by 2 bps.
Both structural and liquidity factors have led to the slow transmission of RBI’s rate cut. Since banks source only a very small portion (1 per cent) of their deposits at RBI’s repo rate, it has always been difficult for them to pass on RBI’s rate action in its entirety. The other issue has been the weak growth in deposits this year. This has limited banks’ ability to lower deposit rates, and hence, lending rates.
But the RBI sought to iron out these chinks in transmission by mandating banks to link their loan rates to an external benchmark (most banks have adopted the repo rate) from October 1. Hence, every time the RBI cuts its repo rate, by design, lending rates should move lower.
Has the repo link worked?
While in many cases the benchmark for lending rates is cheaper under the repo-linked structure than under the erstwhile MCLR (marginal cost of funds-based lending rate) regime, repo-linked loans have not necessarily benefited borrowers a great deal so far. There are several reasons for this.
One, until October, when banks had introduced repo-linked loans, the RBI had already cut its repo rate by 110 bps. Hence, borrowers lost out on the chunk of the rate cut done until then.
Two, even the 25 bps cut in repo rate in October did not translate into a corresponding reduction in lending rates (under repo-linked loans) in many cases. For instance, SBI introduced a benchmark called the external benchmark rate (EBR) in October, which is the repo rate plus 2.65 per cent. Despite the repo rate falling to 5.15 per cent after the October 4 policy (from 5.4 per cent earlier), SBI continues to benchmark its loans against an EBR of 8.05 per cent (which is the earlier repo rate of 5.4 per cent plus 2.65 per cent).
This is because, under the external benchmark structure, the RBI has mandated that loans should be reset at least once in three months. Hence, banks are not compelled to reset their benchmark every time the RBI lowers its repo rate. While transmission is quicker than under MCLR (where home loans were reset mostly once a year), they are not instant under the repo-linked structure. Hence, borrowers may still have to wait a while to get the full benefit of RBI’s rate cuts since October.
Three, different banks have adopted different benchmarks (the spread over repo rate varies vastly across banks). For instance, Bank of Baroda charges a 3 per cent mark-up above the repo rate. SBI charges a spread of 2.65 per cent over the repo rate. On top of this, banks may also charge an additional spread based on the credit profile of borrowers.
Hence, the effective lending rate may still be high and similar to that under the MCLR structure. In other words, a higher spread can eat into the benefits of lower repo rate and borrowers may not gain much.
What should borrowers do?
While the sharp slowdown in economic growth — real GDP growth plunging to 4.5 per cent in Q2 of the current fiscal — provides a compelling case for more repo rate cuts, rising inflation (on the back of increase in food prices) could rein in the RBI’s actions. CPI inflation moving past the RBI’s comfort level of 4 per cent to a 16-month high of 4.6 per cent in October will limit the central bank’s future rate cuts.
Also, the lowest level of repo rate, at 4.75 per cent, was last seen in April 2009. With the repo rate currently hovering just above this level, the RBI’s future rate cuts may be very limited.
Against this backdrop, what should borrowers do?
1. Check out the best deals
It may be a good time to scout the market for cheap loans, particularly in the home loan segment, where banks are actively trying to woo customers. Many banks have also set varied rates based on the borrower’s risk profile and credit score.
Hence, if you have been a disciplined borrower and have a high credit score, you could get a far more attractive deal. For instance, in the case of Central Bank of India, you can get an effective lending rate of 8 per cent on your home loan if you have a high credit score (8.3 per cent for borrowers with low credit score).
While choosing a loan, consider the spread charged to you by each bank. Go with banks that charge a risk premium based on transparent credit bureau scores, rather than opaque internal policies.
Based on information on banks’ websites, as on December 4, for a salaried borrower (male) looking for home loans in the ₹30-75 lakh bucket, Bank of Baroda, Bank of India, Central Bank of India and Union Bank offer among the cheapest rates in the market. The best effective lending rates on these home loans range between 8 and 8.2 per cent. SBI (8.45 per cent), Axis Bank (8.55-9.2 per cent) and ICICI Bank (8.65-8.9 per cent) charge a relatively higher lending rate.
2. Watch out for future volatility
Given that the RBI’s future rate cuts will be limited hereon, remember that when the central bank starts to hike rates in the long run, repo-linked loans can pinch you. A frequent increase in your EMI can lead to more volatility.
Hence, if you are an existing borrower, make the switch to repo linked loans only if the benefit is substantial (on interest savings). If you are at the end of your loan tenure, don’t hurry to move to repo-linked loans.
Depositors’ plight
If you have parked most of your surplus funds in bank deposits, then the sharp cuts by banks since January may have hurt you. In particular, if you are a senior citizen who relies mostly on interest income on deposits to fund living expenses, you may have been hit hard by the sharp reduction in deposit rates in recent months.
While the RBI did not cut its repo rate in this policy, deposit rates could fall further. So, how can you cushion yourself from the pain?
1. Don’t let funds idle in savings account
If you have ample surplus funds, don’t let them lie in your savings account, as most banks offer meagre rates on savings deposits. SBI had in November lowered the interest rate on low-value savings deposits (up to ₹1 lakh) to 3.25 per cent from 3.5 per cent; many other PSBs offer 3.25 per cent on such deposits. Private sector banks such as HDFC Bank, ICICI Bank and Axis Bank offer a slightly higher rate of 3.5 per cent on savings deposits up to ₹50 lakh, which is still very modest.
If you have a very short-term horizon, moving to less-than-one-year FDs can straight away earn you a higher 6.5-6.75 per cent (even 7 per cent in some banks).
2. Look out for attractive rates
If you do not need money immediately, extend your FD tenure to earn higher returns. But stick to a two-to-three-year option at this juncture, as it can allow you to cash in on rate hikes that may come.
Over the past year, private banks and small finance banks have been offering higher rates than public sector banks. So, even if you are comfortable banking with your neighbourhood PSB, open an FD account in other banks to lock into higher rates.
Bandhan Bank (7.25 per cent), IDFC First Bank (7.5 per cent) and DCB Bank are a few private banks that still offer upwards of 7 per cent for one-or-two-year FDs. Small finance banks such as Ujjivan, Fincare, Jana, Suryoday and Equitas offer upwards of 8 per cent on one-to-two-year deposits.