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The Reserve Bank of India (RBI)'s recent decision to slash the repo rate by 25 basis points to 6.25 percent marks a significant development in India's financial landscape. This move, the first repo rate cut in nearly five years, is expected to trigger a ripple effect across the lending sector, potentially leading to a decrease in interest rates on various loan products, particularly personal loans. The reduction in the repo rate, the rate at which the RBI lends money to commercial banks, makes short-term funding more affordable for these institutions. This, in turn, can translate into lower interest rates for borrowers seeking fresh loans.
The impact on personal loan interest rates, however, is not immediate and uniform. While banks are anticipated to pass on some of the benefits of the lower repo rate to their customers, the extent of this transmission varies. The mechanism through which interest rates are adjusted is governed by the marginal cost of funds-based lending rate (MCLR) system, which was introduced in 2016 to replace the previous base rate system. The MCLR considers factors such as deposit rates, repo rates, operational costs, and the cost of maintaining the cash reserve ratio when determining lending rates. Because banks have individual norms and operate under a system of MCLR, which banks use to determine their own rates, this means that the direct impact to customers isn't immediate. This makes it difficult to predict precisely how much personal loan rates will decline.
A key distinction needs to be made between existing and new personal loans. Existing personal loans typically have fixed interest rates that remain unchanged throughout the loan's tenure. Therefore, borrowers with existing personal loans will not experience any immediate reduction in their interest rates due to the RBI's repo rate cut. Conversely, fresh personal loans offered by banks in the coming weeks are expected to reflect the lower interest rates. This implies that only those seeking new personal loans will benefit from the reduced rates. This difference highlights the importance of understanding the terms and conditions of the loan agreement, especially concerning the type of interest rate (fixed or floating).
Home loans and car loans, often characterized by floating interest rates linked to the repo rate, are more susceptible to changes influenced by the RBI's actions. These loans are more likely to see quicker reductions in interest rates compared to personal loans. This is because MCLR is a key element in determining their interest rates. However, even with floating interest rates, the complete transmission of the repo rate cut benefit to borrowers may not be immediate or in the same proportion. Banks typically factor in their operational costs and profit margins before adjusting lending rates, leading to a degree of variance in the extent to which the interest rate reductions reflect the change in the repo rate.
The experts quoted in the article offer varying perspectives on the timing and extent of the rate cut's impact on personal loan interest rates. While some anticipate a transmission of benefits to new borrowers, others highlight that banks have their own individual norms for determining interest rates, meaning that the transmission might not be immediate and may vary significantly between banks. The article also underscores that the 25 basis point cut in the repo rate is being perceived as the beginning of a potential rate-cutting cycle, suggesting further reductions in interest rates might follow in the future. This potential future easing of monetary policy could lead to additional benefits for borrowers in the long term, although the timing and extent of these benefits remain uncertain.
In conclusion, while the RBI's repo rate cut is a positive step towards potentially reducing borrowing costs, it's crucial to approach expectations with realistic caution. While new personal loan borrowers are likely to enjoy lower interest rates, existing personal loan customers will not see immediate benefits. The extent of rate reductions will also depend on individual bank policies and the dynamics of the MCLR system. It remains to be seen how aggressively banks will pass on these benefits to consumers and how quickly this adjustment will occur. Constant monitoring of market trends and bank announcements is advised for those seeking clarity on the impact of these changes on their financial standing.
Source: RBI rate-cutting cycle begins; are personal loan interest rates headed for fall?