Finally Some Cheer

The new RBI governor matched expectations when he announced a 25 basis point cut in the repo rate, which is the rate at which banks borrow from the RBI. The move was factored in by the stock markets, which did not go wild as they would have otherwise. But it will be a good time in the festive season for the common man. Those servicing loans – car and home-- will find their EMIs or tenures down as banks are expected to pass the cut soon. At the same time, it is not so good news for small savers, who will find the rate on bank deposits and small savings dip.

 At present, banks follow the marginal cost-based lending rate or MCLR mechanism for pricing new floating-rate loans. This new regime came into effect from April 1 this year. Earlier banks used to price their loans according to their base rates. Borrowers with home loans still linked to base rates can also shift to MCLR rates for a fee as the base rate is also expected to trend lower after RBI's rate cut. In doing so, they will not have to wait too long for banks or lenders to decide on passing the rate cut benefits to the borrower as it will happen automatically.

 The RBI on its part hopes that the recent cut in small savings rates as well as its steps to infuse liquidity into the financial system will help banks to transmit its rate cuts to customers. In its policy statement, the apex bank said: “The easy liquidity conditions engendered by the Reserve Bank's operations should also enable the smooth transmission of the policy action through various market segments. Furthermore, banks should find added impetus for better transmission by the recent downward adjustment in small savings rates."

 MCLR is a boon for borrowers because without it they rarely benefit from policy rate cuts. For instance, since January 2015, the RBI has cut the repo rate by 175 basis points but banks have passed less than half of the central bank's rate cut to their customers. Although RBI's rate cut provides banks some room to lower their lending rates, they are not compelled to pass the rate cut benefits to borrowers. However, banks notoriously reduce deposit rates on fixed deposits, which impact those looking for safe havens with their monies.

 Assuming banks cut their interest rate cut by 25 bps, it would result in monthly savings of Rs 488 for borrowers with home loan of Rs 30 lakh, assuming their existing loan rate at 9.5 per cent for 20-year tenure.

Loan Sum (Rs lakh)

EMI at 9.50% (Rs)

EMI at 9.25% (Rs)

Reduced EMI

Annual Savings (Rs)

50

46,607

45,793

813

9,759

75

69,910

68,690

1,220

14,438

Loan tenure of 20 years

 Small saver’s pain

Some of the leading banks like SBI, ICICI Bank and HDFC Bank offer 5-6 year fixed deposits at 7-7.25 per cent rates, compared to the 7.8 per cent that the post office deposit pays. The rates on small savings are also going to fall, even if marginally from this month, which leaves the 8 per cent Government of India bond and the PPF among the best option for those looking for fixed return instruments. The only respite for small savers is the statement spelt out by the RBI governor which mentions 4 per cent as the inflation target. The scenario for retirees and those depending on fixed return instruments as a source of income, times are not good.