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Impact of RBI Repo Rate Hike on Financial Sector

IndianMoney.com Research Team | Posted On Friday, April 19,2019, 03:23 PM

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Impact of RBI Repo Rate Hike on Financial Sector

 

 

The rate at which the commercial banks borrow money from the RBI is known as Repo rate. Repo rate is an instrument of the monetary policy in India. Whenever there is a shortage of funds, the commercial banks borrow money from the RBI and pays interest on the same. The rate of interest on the borrowed funds is known as the repo rate. The present repo rate is 6.25% from 7th February 2019. A reduction in repo rate helps banks get money at a cheaper rate and vice versa. The repo rate in India is similar to the discount rate in the US.

When RBI hikes the repo rates it makes borrowing costly for the banks. Consequently, the banks hike the lending rates for borrowers. Listed below are some the effects of recent hike in the repo rate by RBI:

Effects on Inflation

An increase in the repo rate compels the banks to pay a higher interest rate to RBI. As a result, the lending rates for the bank customers also increases. This discourages borrowers to avail credit from the commercial banks thus leading to a shortage of funds. So, inflation is controlled by the increase in the repo rate and thus the flow of excessive money in the economy is administered. However, the growth of the economy hits a low as corporates avoid getting loans at high rates of interest which in turn leads to a shortfall in the expansion of business and production activities.

See Also: Interest Rates Effect on Inflation

Effects on fixed deposits

An increase in the repo rate also causes a shortfall of funds for the commercial banks. With scarcity of funds, banks will refrain from lending credit to borrowers. The scarcity of funds can prompt the bank to increase the rate of interest on fixed deposit to attract depositors. Hence the hike in repo rate consequently impacts the interest rate of fixed deposits.

The short-term impact of this hike doesn’t give positive indications for the investors who tend to park their money in FDs. RBIs long-term policy is now aimed at retail inflation. Once the inflation rates are lowered, the prospects of parking funds in FDs over the long term would offer lucrative benefits. 

Effects on Borrowing

When there is an increase in the repo rate, loans for the customers are much more expensive because of the hike in interest rates. This is because commercial banks acquire funds from the central bank at higher prices, which pushes them to increase their repo rate.

Most of the times the impact of hike in repo rate does not necessarily get translated immediately into higher rates on fixed deposits. When the repo rate increases, banks are quick to raise the lending rates which would mean higher EMI s on car loans, personal loans and home loans. This also discourages the customers to borrow money from commercial banks.

Effects on Home Loan:

A hike in the repo rate will have direct effect on borrowers as the banks are likely to increase the interest rates on loans. If the loans of the existing customers are MLCR-linked, the EMI burden is likely to increase. The increase in EMI will be felt by the borrowers when the reset date of their home loan arrives. In the reset date the future EMIs will be calculated based on the MLCR effective on such dates.

If you are a bank customer planning to take a home loan post increase in the rates of interest then you should wait for some time and look for the rates of interest offered by other banks. For new borrowers, it is always advisable to conduct a thorough research on the various home loan interest rates offered by various lenders before selecting a particular one. The new borrowers can consider opting for the Pradhan Mantri Awas Yojana Scheme. It is a credit linked interest scheme offered on the basis of your income level.

See Also: Features of a Car Loan and a Home Loan

Effects on the Economy

Repo rate is a tool in the Indian monetary policy that can be used to regulate the money supply in the economy as well as check inflation levels and liquidity. Also, repo rate has a direct relationship with the cost of borrowing. Higher the repo rate, higher will be the cost of borrowing.

Repo rates increase during a high level of inflation due to which the RBI makes strong attempts to reduce the money supply in an economy. This makes borrowing costlier for industries and businesses which in turn slow down investment and money supply in the economy.

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