The current unchanged repo rate is no guarantee of a stable interest rate on loans.
Street Talk
Expert Opinion
The Reserve Bank of India (RBI) during its third monetary policy committee (MPC) meeting for 2024 on August 8, has kept the repo rate unchanged at 6.50 per cent. This is for the ninth consecutive time the rates have remained unchanged. However, indications are that this benchmark rate may see a sizable cut in the forthcoming Monetary Policy Committee (MPC) meetings, subject to inflation staying within the RBI’s target range and a slight moderation in food inflation.
Technically speaking, unchanged repo rate means the rate of interest on loans vulnerable to this policy rate such as personal, vehicle, housing, gold loans etc. will not change and there would be no impact on the Equated Monthly Installments (EMIs) of the borrowers. This means borrowers with loans linked to the repo rate will experience stability in their interest rates.
Notably, the Repo Rate (repurchase rate) is the rate at which banks borrow funds from the RBI against any kind of collateral like treasury bills, gold, and bond papers. Whenever banks are short on money, they borrow it from the RBI. When the RBI lends money to banks, it charges banks interest on the principal amount of the loan. For example, if the repo rate is 6.5%, and the bank takes a loan of Rs.1,000 from RBI, then the bank will pay interest of Rs.65 to the RBI.
Actually, the repo rate is one of the crucial financial handles which drives the country’s economy. Its percentage is a benchmark rate used by banks to fix the rate of interest on loans across various sectors of the economy. The change in repo rate not only impacts rate of interest on loans, but the deposits also see changes in the percentage of interest.
Interestingly, with more and more common households banking upon loans to keep their domestic affairs afloat, the Reserve Bank of India (RBI) actions vis-a-vis rate of interest on loans are being closely monitored at mass level. Be it employees in government and private sector, people engaged in big or small businesses, students, pensioners or street vendors, the RBI’s monetary policy stance announced at regular intervals has become their most concerning affair. today, the most technical terms in financial matters such as cash reserve ratio, statutory liquidity ratio, bank rate, repo rate, reverse repo rate etc. are no more hard nuts to crack for a common man. They understand that any flirting by the RBI with these policy rates has direct bearing on their household budgets. It’s the repo rate which is very closely monitored by common consumers. This rate decides the cost of borrowing for them.
Notably, several aspects of the economy are sensitive to changes in the repo rate, including inflation, currency exchange rates, and overall economic growth. Even as the repo rate is key to keep inflation under control, it affects the cost of borrowing and also acts as a money supply management tool. When inflation is to be curbed, the RBI raises the repo rate. This raises the cost of borrowing as banks have no alternative but to hike interest rates on loans to keep their cost of funds within their range. The high interest rates discourage borrowers to avail loans and as a result, banks witness drop in their lending activities. Ultimately, the overall money supply in the economy decreases as consumer spending declines. While impacting the demand side in the market, the inflation starts cooling down.
However, if inflation is low, then it means that there is less demand for goods and services. To promote spending and increase demand, RBI decreases the repo and reverse repo rates. As interest rates decrease for the banks, banks start to offer loans at a lower rate. Thereby people start borrowing the money and start to spend.
Meanwhile, the Reserve Bank of India (RBI) leaving the repo rate unchanged at 6.5 percent, the cost of borrowing is still at higher side and is no guarantee that banks won’t increase the interest rate on loans in the near future. It is worth mentioning that the central bank has expressed its displeasure to the banks about the escalating volume of unsecured personal loans and in a pre-emptive measure has directed the banks and other regulated entities to maintain the risk weight of 125% on consumer credit instead of 100% mandated as earlier. This means the banks will have to set aside a higher amount as loan provisioning. This is a scenario where the banks and other regulated entities are left with an option to raise the rate of interest on loans despite unchanged repo rate.
Notably, it was on November 16, 2023, the RBI advised banks and other regulated entities to stick to 125% risk weight on unsecured loans. According to the available data, “The bank credit growth increased by approximately 20%, retail loans surged by 30%. Among these, credit card debts are estimated to have risen by around 30%. Banks have also extended loans to non-banking finance firms engaged in offering unsecured personal and consumer loans.”
Even as the impact of the upward revision of the risk weights could vary among individual lenders depending on their exposure to unsecured loans, the move is all set to lead to higher interest rates on loans.
The bottomline is that there are various market factors other than the repo rate factor which trigger change in interest rates. Here, the borrowers have to act smart. They have to understand that the current unchanged repo rate is no guarantee of a stable interest rate on loans. As is evident from the market scenario, it could be a lull before a storm. A borrower must focus on his financial health to maintain it stable in all conditions.
While opting for loans, it is always advisable to look beyond the initial years and calculate the potential impact that EMI payments will have on your future financial life. Ensure total EMI of your loans remains below 40 percent of your take home salary. Examples galore which suggest that anything outside this range puts a borrower into a debt trap. Don’t get lured to small/affordable EMIs. Always remember that your monthly budget and cash flow position is always changeable under the circumstances of repaying a bank loan. Check your net income (inflow) and expenditure (outflow) and the difference between the two will give you the quantum of your cash reserve. This cash reserve figure is the actual empowerment you possess to decide the amount of loan you can obtain and repay without any default.
To conclude, the power of a bank loan has two sides. It can either bring prosperity to you or leave you in a debt trap. It is just a matter of good financial planning.
(The author is a veteran journalist/columnist. He is former Head of Corporate Communication & CSR and Internal Communication & Knowledge Management Departments of J&K Bank)