The Reserve Bank of India (RBI) has recently reduced the repo rate by 25 basis points to 6.25%, with expectations of further cuts in upcoming monetary policy meetings, potentially leading to cheaper loans. A repo rate cut generally lowers borrowing costs, making loans more affordable. However, borrowers often do not see an immediate reduction in their Equated Monthly Instalments (EMIs) due to the way banks determine interest rates.
A rate cut does not instantly translate into lower loan payments; the impact varies based on factors such as loan type, bank policies, and interest rate calculation methods. Understanding these factors can help borrowers manage their loans more efficiently. Let’s decode how a repo rate cut affects your loan liabilities.
How Loan Rates Are Decided
Banks determine lending rates using two main benchmarks: the External Benchmark Lending Rate (EBLR) and the Marginal Cost of Funds-Based Lending Rate (MCLR). EBLR is directly linked to external factors like the RBI’s repo rate or government bond yields, making it more responsive to repo rate changes. Many home loans, personal loans, and MSME loans follow this system. MCLR, on the other hand, is based on a bank’s internal cost of funds and operational expenses. Since MCLR does not directly follow the repo rate, loans tied to it may take longer to reflect a reduction in interest rates.
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Fixed vs Floating Interest Rates
Loans can either have fixed or floating interest rates. Fixed-rate loans, such as personal loans, auto loans, and credit card loans, remain unchanged throughout their tenure. This means borrowers with such loans will not benefit from the repo rate cut.
Adhil Shetty, CEO of Bankbazaar.com, explains, “Floating-rate loans, like home loans and business loans, fluctuate with market conditions. However, even these do not change instantly when the repo rate is cut. They are revised at specific intervals, usually every three or six months. This delay in adjustment is why many borrowers have not yet noticed a change in their EMIs.”
Why You Haven’t Seen a Rate Cut Yet
Most floating-rate loans do not immediately adjust when the repo rate changes. Instead, they are reset periodically, based on their pre-determined reset schedule. For instance, if a loan is linked to the repo rate with a six-month reset cycle,
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