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Why Aren't Loans Getting Cheaper Despite RBI's Multiple Repo Rate Cut?

IndianMoney.com Research Team | Posted On Tuesday, January 28,2020, 11:52 AM

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Why Aren't Loans Getting Cheaper Despite RBI's Multiple Repo Rate Cut?

 

 

Reserve Bank of India is the Central bank of the country. It regulates the entire banking sector in the country. RBI controls the issue and supply of currency (rupee) in the country. RBI lends to all private and public sector banks in India. The rate at which RBI lends to banks is called the repo rate.

When the repo rate reduces, banks cut loan rates. In an ideal environment, a reduction in the repo rate reflects on the final customer as well. This benefit must be passed on to customers by reducing the interest rate on floating-rate loans. However, in the current scenario, this is not happening. Why? Let’s take a look.

RBI makes the decision to increase or decrease the repo rate, considering the liquidity in the market. On October 4th 2019, RBI reduced the repo rate by 25 basis points. As a result of this, the current repo rate is 5.15%. This is the 5th time in a row RBI is cutting the repo rate in the same financial year.

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Why Aren't Loans Getting Cheaper Despite RBI's Multiple Repo Rate Cut?

Why Aren’t Loans Getting Cheaper?

In spite of this repo rate reduction, loans are not being cheaper because the banks are reluctant to pass on the benefits to customers. Back in 2014, the repo rate was 8%. Now, it is down to 5.15%. Yet, banks have not reduced interest rates in proportion to the repo rate cuts.

Some banks have brought in extremely negligible changes to their interest rates. SBI cut down lending rates by 5 bps with effect from November 10th. After the cut, 3-year MCLR came down to 8.2% from 8.25%. MCLR is the marginal cost of funds based lending rates. It is the minimum interest rate at which a bank can lend. HDFC reduced MCLR for 6 months, 1 year and 2 years tenure by 5bps each. The current rates are 8.10%, 8.30%, and 8.40% respectively. When RBI reduced the repo rate by 135 basis points, the one-year MCLR decreased only by 49 basis points.

See Also: How To Invest If RBI Cuts Repo Rate?

Customers are facing a hard time and banks are taking advantage of this. In simple words, they are borrowing money from RBI for a cheaper rate and lending them to customers at a much higher rate. This profit margin is enjoyed by banks alone. Now another obvious question in the minds of the customers is:

Why RBI is Not Forcing Banks to Transfer the Rate Cuts?

RBI and the government have repeatedly urged banks to reduce their interest rates. RBI has also made it mandatory to link floating rates of personal or retails loans to external benchmarks from October 1st 2019. This is done to ensure the banks would transfer the benefits to customers immediately.

This has not proved beneficial, as banks increased their margins. This was done exclusively to prevent the passing of benefits from the repo rate cut to the customers.

According to the external benchmark system, banks use the repo rate as the reference rate. Customers who have availed floating rate loans will enjoy interest rate cuts in-line with repo rate cuts. This reset of interest rates in accordance with external benchmarks takes place only once a quarter.

See Also: Repo Rates Cut 4 times a year, will your Home Loan rates fall?

As this repo rate cut was in October, it is expected that banks will reduce their interest rates during the month of January, although no such news has come out.

Solution: Operation Twist.

Operation twist is the process of simultaneous purchase and sale of government securities under the open market operations (OMO). The RBI manages and controls liquidity, the strength of rupee and monetary management through the purchase of government securities.

When RBI is of the opinion that excess liquidity prevails in the market, it opts to sell securities, thereby absorbing the excess money in the market. On the other hand, when liquidity conditions are tight, RBI will buy securities and release funds into the market.

See Also: Repo Rate vs Bank Rate

How is This Going to Bring Down Interest Rates?

On December 23rd 2019, RBI sold short term securities worth Rs 10,000 crores and bought long term securities for the same amount. This simultaneous buying and selling of securities reduces long term interest rates and increases short term rates. When the government buys long term securities, their demand and price rise. When the price goes up, the bond yield comes down (inverse relation). As a result of all this, now people can avail long term loans like home loans, car loans and so on at lower rates.

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