Experts suggest that loans linked to the Repo Linked Lending Rate (RLLR) may see an immediate impact, depending on the reset interval specified in the loan agreement. However, the Marginal Cost of Funds Based Lending Rate (MCLR) linked loans and new loans could take longer to reflect the change due to the rising cost of funds for banks.
Repo rate-linked loans are directly tied to the RBI’s repo rate and are usually reset at intervals of one, two, or three months. “When the RBI reduces the repo rate, borrowers will see a lower interest rate in their next scheduled reset cycle. For instance, if a loan resets every three months and the repo rate is cut today, the lower rate will be applied in the next quarter’s interest revision,” explained Adhil Shetty, CEO of BankBazaar.
Meanwhile, MCLR-based loans take longer to reflect repo rate cuts, as MCLR is influenced by a bank’s cost of funds, which adjusts gradually. "Repo rate-linked loans adjust faster since they are directly tied to the repo rate and reset at pre-defined intervals. However, loans linked to MCLR take longer to reflect the change because MCLR factors in a bank’s overall cost structure. If deposit rates stay high, MCLR may not fall quickly," said Shetty.
Since 2019, the RBI has mandated that all new loans be linked to external benchmarks, such as the repo rate, to ensure better transmission of rate cuts. However, existing borrowers still had the option to stick with MCLR or switch to repo rate-linked loans. The speed of rate transmission for MCLR linked loans depends on how quickly banks adjust their cost of funds.
Currently, banks are experiencing compressed Net Interest margin (NIM), as spreads continue to tighten. According to the Care Edge Ratings report, in December 2024 the spread between the outstanding weighted average lending rate (WALR – Lending Rate) and the weighted average domestic term deposit rate (WADTDR – Deposit Rate) for scheduled commercial banks (SCBs) compressed by 4 basis points (bps) m-o-m to 2.85%.
“You have to look at this in two parts—existing customers with ongoing loans and new customers taking loans in the future. For existing loans, each bank will reprice loans based on individual contract terms. Transmission doesn’t happen immediately, even though borrowers expect it within 24-48 hours. The timeline varies across banks, depending on individual agreements with borrowers,” said a senior official of a private bank on the condition of anonymity. For new borrowers, transmission will take longer. As banks see their cost of funds improving, the actual cost of borrowing will gradually decrease, eventually leading to lower interest rates for customers, he added.
"Banks set lending rates based on their cost of funds, which includes deposit rates, market borrowings, and regulatory requirements. Even if the RBI cuts the repo rate, banks may not immediately lower lending rates if their funding costs remain high. For instance, if banks have locked in fixed-rate deposits at higher rates, they cannot reduce loan rates without squeezing their margins," said Shetty.
Borrowers should review their loan agreements to check reset periods and evaluate whether switching to repo rate-linked loans would be beneficial. Those with MCLR-linked loans might have to wait longer for rate cuts to reflect, while new borrowers may not see immediate benefits as banks adjust their lending rates cautiously.