Repo rate is a financial instrument that the Reserve Bank of
India implements to regulate the flow of money and credit in the Indian
economy. Repo rates are subject to frequent alterations by the RBI in an
attempt to align the lending policies of financial institutions with the
Government of India’s (GOI) objective of controlling credit supply,
consumption, liquidity, and growth.
HFCs extend the impact of changes in the repo rate
to individuals availing credit such as home loans, personal loans, business
loans, among other borrowing options. As an extension, loan interest rates
undergo variations periodically as per the prevailing repo rates.
Why does RBI regulate repo rate?
Repo rate or repurchase rate refers to the interest rate that
RBI charges on financial institutions when they borrow funds from the RBI.
Lenders borrow a percentage of their monetary operations from the RBI based on
this rate.
It is also vital to consider the reverse repo rate, which is the
rate of interest applicable on deposits made by financiers or lenders to the
RBI.
The RBI therefore changes repo rate periodically which affects
the lending rate at which financiers lend a credit to an individual. The RBI
also uses repo rate as an instrument to control the availability of credit to
individuals as per their demand, consumption, and spending parameters.
How does repo rate influence interest
rates on loans?
Repo rate decided by the RBI has extensive impacts on the
interest rates charged by a lender on different categories of loans. It is
calculated by basis points (bps), where 100 bps equals 1% of repo rate. For
instance, the current repo rate is 5.15%, down from 5.40% by 25 bps.
Individuals should plan their loan requirements as per RBI rate cuts and what to expect from such announcements.
Fluctuations in repo rate have direct implications on the
interest rates charged by lenders on individuals availing home
loans, business loans, and personal loans. The
impacts on rates of interest on the basis of repo rate are as follows –
●
Increase in repo rate
Lenders have to pay higher interests on the funds borrowed from
the RBI when the repo rate is increased. This causes a reduction of available
funds present with the financial institutions.
With the reduction in the lenders’ loanable funds, the cost of
availing credit increases. This implies that loans are available to individuals
at a higher rate of interest and higher EMI payment.
RBI increases repo rate to primarily curb inflation and flow of
credit by reducing the volume of loanable funds. This measure aims to
discourage individuals from availing loans from financial institutions owing to
a significant increase in cost of loans.
●
Decrease in repo rate
RBI curtails repo rate to increase credit availability in an
economy. As lenders are liable to pay lower rates of interest on the funds
borrowed from RBI, they can retain a substantial corpus of loanable amount. A
higher supply of loanable funds suggests that financial institutions charge
affordable rates of interest and lower EMIs on individuals availing credit.
The objective behind a reduction in repo rate is to enhance
money supply within an economy by making loans affordable. Individuals can thus
access higher amounts at attractive interest rates to finance their
requirements.
New external benchmark for financial
institutions
Financial institutions accumulate a major percentage of loanable
funds from long term deposits from their customers. The remaining fund volume
is borrowed from RBI, which is a limited portion of loanable funds. Financial
institutions are thus often slow to transmit the impacts of repo rate
alterations to their customers.
To combat this, the RBI introduced the following new external
benchmark for all loans including home loan in effect from 1st
April, 2019 to provide customers benefits on floating interest rates and more
holistic revisions to the rates –
●
Repo rate determined by the RBI.
●
GOI’s Treasury bill yield for 3 months.
●
GOI’s 6 months’ Treasury bill yield.
●
Other benchmarks as applicable.
HFCs that select repo rate as a benchmark offer Repo Linked
Lending Rate (RLLR) to their customers to incorporate the direct influences of
repo rate fluctuations and adding transparency in the MCLR calculation process. Individuals should check repo rates
to have an idea about how the RBI’s rate hike is likely to affect their loans.
The RBI thus regulates repo rate to control credit availability.
This instrument has direct impacts on lending rates of the credit availed by
individuals. Loan applicants should check the tax saving and other advantages
offered by home loans.
