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How repo rate cut affects on Loan EMIs

Updated on August 19, 2015
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Hi this is Shruthi from India. I am an independent financial adviser specializing in comprehensive financial advice.

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RBI Repo Rate Cut Impact on Loan EMIs

Quite recently, the apex bank of India, the Reserve Bank had announced a cut in the repo rate. This repo rate cut was seen as a great reliever for customers who have an on-going loan. In this article we will see what exactly is repo rate and how does an increase or decrease in this rate affect the banks and the customers. Loans and deposits are the two main financial tools that get affected the most by a change in the repo rate.

What is repo rate?

Repo rate is defined as the rate at which the Reserve Bank of India lends money to other commercial banks of the country in case of shortage of funds. The up and down movement of the repo rate is controlled by financial authorities to arrest inflation in the country. When inflation is more the repo rate is increased so that banks will borrow less and supply of money will be less in the economy and as such inflation will go down. Conversely, a decrease in the repo rate increases lending by commercial banks and hence the money flow in the economy thereby fuelling inflation.

Example: Suppose if the repo rate is 6% and bank XYZ borrows Rs.1,00,000 from the RBI then the interest amount that the bank needs to pay to the RBI comes out to be Rs.6,000.

Effect of repo rate on interest rates

The rate of interest at which banks lend money to customers as loans gets affected by any movement in the repo rate. Generally, a cut in the repo rate decreases the rate of interest on fixed deposits as well as loans. While a cut in the interest rate of deposits might prove unprofitable to customers, a cut in the interest rate of loans is generally seen as a welcome change.

When the repo rate is cut, banks are required to pay lower rate of interest to RBI and hence they charge lower rates from customers. RBI revises its repo rate every quarter and the rates of other commercial banks are hence revised accordingly. Conversely, when the repo rate is hiked by the RBI, banks are compelled to pay higher interest rates to RBI in return of borrowed cash and as such they charge higher rates from customers.

However, an increase or decrease in the repo rate might not always translate into some rate change for customers too. Sometimes, banks’ policies or functions are such that they do not allow immediate rate change implementation and hence customers have to wait for repo rate change to translate into any substantial effect on their borrowing or deposit rates. Currently, the demand for deposits is low and such a cut in the repo rate might not necessarily lower the rate of interest on deposits since this will further lower the demand for deposits.

Lowering of repo rate by RBI means that the base rate of banks is lowered which in turn means the final interest amount that loan customers are required to pay on their loans also gets decreased. This in turn translates into lowered Loan EMI amounts. Therefore, it is safe to say that a repo rate cut lowers the loan EMIs of customers. Generally. Home loan and car loan borrowers should be happy whenever a repo rate cut is announced. Since the loan amount for both these loans is substantial enough, any slight movement also in the rate of interest has a major impact on the final interest amount that a borrower pays and also on the monthly installment that is paid by the customer. Online Loan EMI calculator can be used to calculate any change in the monthly EMI that might result from a repo rate change.

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