RBI leaves repo rate unchanged: What this means for home loan borrowers, FD investors

The Reserve Bank of India (RBI), in its fourth bi-monthly monetary meet held on October 9, 2020 , has decided to keep the repo rate unchanged yet again with accomodative stance. This is the second time in a row the apex bank has kept the key rates unchanged.

The repo rate and reverse rate remain at 4 per cent and 3.35 per cent, respectively, after the announcement. RBI keeping the repo rate unchanged in this monetary policy review was expected by many market participants due to the rising inflation and growth uncertainty in the country.

Borrowers who are facing salary cut/job loss due to the novel coronavirus pandemic situation and were looking for some reduction in their equated monthly instalment (EMI) burden will have to wait a little longer. On the other hand, no change in policy rates means good news for fixed deposit (FDs) investors as banks may go slow on cutting interest rates on FDs.

Here's what borrowers and fixed deposit investors can do after today's announcement.

Existing borrowers
A) Loans linked to external benchmark
Borrowers whose loans are linked to an external benchmark are likely to pay the same EMI for now unless their bank reduces the margin or spread on loan interest rates. However, if your bank raises the risk premium on your loan account, then the EMI on your home loan is likely to increase.

B) Loans linked to MCLR
With no change in the repo rate, any change in the Marginal Cost Based Lending Rate (MCLR) will now depend on bank-specific internal factors. Remember, a bank's MCLR is determined both via internal factors such as cost of funds and external factors such as repo rate etc.

Usually, home loans linked to MCLR comes with a reset period of either one-year or six months. Thus, even if your bank reduces its MCLR, the reduction will result in lower EMIs only when the reset date of your home loan arrives. On the reset date, your future EMIs will be calculated based on the interest rate prevailing on that date (i.e., reset date).

In September, SBI via its official Twitter handle announced it has reduced the MCLR reset frequency for loans given by it from one year to six months. This means that SBI's borrowers having home loans linked to the bank's MCLR will get the benefit of any policy rate changes faster.

Borrowers also have the option to switch to a loan linked to an external benchmark. The switch can be done by paying an administrative fee as set by the bank. However, financial planners suggest that one should only shift if the difference in the interest rates between loans under the two regimes is more than 0.50 per cent.

C. With loans linked to base rate or BPLR
If a home loan is still linked to the base rate or Benchmark Prime Lending Rate (BPLR), then a borrower should consider switching to an external benchmark-based loan. The new lending rate regime offers better transmission of RBI policy rates in comparison with the base rate and BPLR rate-linked loans, as per financial planners and industry experts.

Currently, SBI's BPLR is at 12.15 per cent and base rate is 7.40 per cent. However, the bank's repo rate-linked loan interest rate starts from 7 per cent.

New borrowers
Yes, banks have reduced interest rates on loans over the past year or so, but if you are looking at availing a loan, do ask yourself these eight questions first.

Further, do check and compare the margin and risk premium charged by banks over and above the external benchmark to get the lowest interest rate.

Do keep in mind that not all banks have chosen the repo rate as an external benchmark. Some banks have linked the interest rate on loans to certificate of deposit rate, treasury bills etc. Remember, as per RBI guidelines, loan on interest rates can be linked to any of these benchmarks:
(a) RBI's repo rate
(b) Govt of India 3-month Treasury bill yield published by Financial Benchmarks India Pvt. Ltd
(c) Govt of India 6-month Treasury bill yield published by Financial Benchmarks India Pvt. Ltd
(d) Any other benchmark market interest rate published by Financial Benchmarks India Pvt. Ltd

New borrowers need to keep in mind that external benchmark-linked interest rates are likely to be more volatile compared with MCLR linked rates. This is because changes in the external benchmark - both increases as well as decreases -- are transmitted faster than via MCLR.

New borrowers (if eligible) can also apply for home loan under Pradhan Mantri Awas Yojana (PMAY). It is a credit linked subsidy scheme where middle income group - I (MIG -I) with income between Rs 6 lakh and Rs 12 lakh can avail interest subsidy of 4 per cent whereas middle income group - II (MIG -II) with income between Rs 12 lakh and 18 lakh can get interest subsidy of 3 per cent under the scheme.

A likely pause in reduction in FD interest rates
Just as banks have been cutting interest rates on loan, they have been announcing reductions in their FD rates as well. So, no change in key policy rates may prompt banks to go easy on cutting fixed deposit (FD) rates.

For instance, in its latest FD rate reduction announcement, the State Bank of India (SBI) said that it has cut FD rates by 20 basis points on its one-year FD with effect from September 10, 2020. The interest rate on SBI's one-year FD now stands at 4.9 per cent, down from 5.1 per cent earlier. Similarly, HDFC Bank's one-year FD is offering 5.1 per cent, with effect from August 25, 2020.

In a relief to the small savings schemes investor, the governemnt has decided to keep the interest rate unchanged for the third quarter of FY 2020-21. No change in the interest rate of post office deposit schemes would be a relief for investors who are already reeling from the interest rate cuts on the fixed deposits.

As an alternative to FDs, investors can consider investing in the Pradhan Mantri Vaya Vandana Yojana (PMVVY) or RBI floating rate savings bonds, 2020. Do keep in mind that PMVVY offers fixed interest rate throughout its tenure, whereas the interest rate on RBI's floating bonds is reset every six months; the first date being January 1, 2021.