RBI has not cut repo rate, but your EMIs may still go down; here's why

Even though RBI's Monetary Policy Committee has decided to keep the repo rate unchanged, home loans and car loans borrowers, who have taken loan at floating interest rate or are planning to take such a loan, can still look forward to a reduction in their EMIs. Typically, banks are expected to reduce interest rates when the RBI cuts the repo rate, which is the rate at which banks borrow from the apex bank.

Since RBI has not cut the repo rate, loan customers should ideally not expect a drop in the interest rates on loans. But, that's not the case this time around since there is pending repo rate reduction that is yet to be transmitted to retail borrowers.

Let us explain.

The RBI has reduced repo rate by 2.85 per cent from 8 per cent in January 2014 to 5.15 per cent in October 2019. But, banks have not transferred this rate cut in entirety to consumers. Take, for instance, the example of State Bank of India (SBI)'s interest rates on Rs 30 lakh loans as the benchmark.

In the period between 2014 and September 2019, SBI has reduced interest rates from 10.15 per cent to 8.15 per cent in September 2019. This means the state-owned lender is yet to pass on 0.85 per cent of interest rate on to consumers to match RBI's repo rate cut.

Also Read: Why RBI's MPC decided to put temporary pause on easing of repo rate

Notably, the RBI made it mandatory for banks to link all new floating rates personal or retail loans, including home loans, to key lending rates, also called external benchmarks, from October 1. This essentially is supposed to force banks to transfer the repo rate cut to customers.

Soon after the RBI's decision, SBI introduced home loan with external benchmark but hiked its margin by 0.40 per cent to 2.65 per cent from 2.25 per cent earlier under MCLR regime, which kept interest rates on the higher side for new customers. So, things didn't change much for the borrowers.

But, banks can now alter its margin only after 3 years. Also, banks cannot prevent full transmission of interest rate changes to the borrowers. SBI had declared the external benchmark rate in October before the RBI reduced the repo rate by 0.25% on October 4. So, it's yet to pass on the benefit to the borrowers.

Also Read: MPC meet: RBI revises GDP forecast to 5%; says economic growth has weakened further

However, reset of interest rate as per the changes in the external benchmark has to be done once in a quarter. Since all banks had last fixed their rate in the month of October this year, so the next reset will take place in January when banks will reduce the interest rates to match the drop in corresponding external benchmark. As most of the banks have selected repo rate as their benchmark, loan subscribers can look forward to a drop in their EMIs.

Therefore, at the beginning of next quarter, which is January 2020, SBI will have to pass on the benefit of this 0.25% reduction to the borrowers with external benchmark linked loans.

As the margin above the repo rate which banks are typically charging on old floating rate loans is on the higher side, there is a good scope for MCLR linked loans to expect some gradual reduction in the interest rate. Declining interest rate in the economy is bound to bring down cost of the funds of the banks. So despite RBI keeping the repo rate unchanged, borrowers with loan linked to MCLR can hope for some rate reduction going forward.

Edited by Manoj Sharma