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What RBI's repo rate cut means for loan EMIs

What RBI's repo rate cut means for loan EMIs

What RBI's repo rate cut means for loan EMIs
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By Anshul  May 22, 2020 12:12:20 PM IST (Updated)

Repo rate is the rate at which the central bank lends money to commercial banks.

The Reserve Bank of India (RBI) on Friday announced a 40 bps cut in repo rate to 4 percent from 4.4 percent earlier. Repo rate is the rate at which the central bank lends money to commercial banks.

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For borrowers, this is a positive news, especially for those whose loans are linked to external benchmarks like the repo rate, according to experts.
"The recent rate cut is likely to reduce equated monthly installments (EMIs) of borrowers, and also make it cheaper to take new loans," they say.
A cut in repo rate means cost of borrowing will be lower for commercial banks. The rate cut will further help banks to lower loan interest rates for borrowers.
“The transmission of the latest rate cut will be faster in case of loans linked to repo rate. New applicants and existing borrowers of loans linked to repo rates will benefit from the policy rate reduction as and when banks reset the interest rates of their repo-rate linked loans,” says Naveen Kukreja- CEO and Co-Founder, Paisabazaar.
"However, the transmission of rate reduction will be incomplete for the fresh borrowers if the banks simultaneously increase their spread or credit risk premium during their interest rate reset," he adds.
For borrowers whose loans are linked to the marginal cost-based lending rate (MCLR), the benefit will only be passed when their bank reduces loan rates.
MCLR is dependent on both external and internal factors of the bank. Also, banks have a rest period, which is taken into consideration in case of MCLR.
"The policy rates set by the MPC is not the sole factor determining the banks’ MCLR. Banks also factor in their cost of deposits while determining their MCLR. Hence, the full transmission of the rate cut in the MCLR-linked loans will take some time," Kukreja explains.
Existing borrowers with MCLR-linked loans will continue to repay their loans according to the existing rates till the next interest rate reset date of their loans.
The reset period is usually mentioned in the loan agreement with the bank. Banks generally offer a rest period of 1 year for MCLR-based loans. For the borrowers, this means that banks will have to reprice the interest rates on loans after 1 year to pass on any changes in the external benchmark rate.
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