The Reserve Bank of India (RBI) periodically lowers or raises the repo rate in order to control inflation, liquidity, and economic growth as a whole. When the repo rate is reduced, it usually indicates a decreased cost of borrowing for banks that should, in theory, result in reduced Equated Monthly Instalments (EMIs) for borrowers. Yet, in most instances, even after a repo rate reduction, EMIs do not change. Why this happens has been investigated by us with illustrations from real-life situations.
Understanding Repo Rate and Its Impact on Loans
The repo rate is the rate at which the RBI lends to commercial banks. When the repo rate is cut, banks are able to borrow at cheaper rates, theoretically allowing them to transfer the gains to customers in the form of lower lending rates.
But the eventual pass-through of repo rate cuts to loan EMIs is based on various considerations, such as the nature of the loan, the internal cost structures of banks, and the implementation of monetary policy.
Why EMI Doesn’t Change in the Face of Repo Rate Cuts?
1. Incomplete Transmission of Rate Cuts: Banks don’t directly transfer the advantage of falling repo rates to borrowers because of their internal cost factors, i.e., their desire to retain Net Interest Margins (NIMs).
2. Fixed and Floating Rate Loans: Borrowers with fixed rate loans do not gain from cuts in repo rate since their rates do not change during the life of the loan.
3. Benchmarking Issues: Loans that are based on older benchmarks (like the Marginal Cost of Lending Rate – MCLR) do not typically react at once to repo rate changes. Only loans that are linked to external benchmarks, like the Repo Linked Lending Rate (RLLR), have quicker transmission.
4. Bank Liquidity and Risk Considerations: Banks, if liquidity-constrained or expecting economic uncertainty, might resist cutting lending rates even when the RBI cuts the repo rate.
5. Outstanding Loan Agreements and Reset Horizons: Periodic reset clauses in some loans imply that rate changes only come into effect after a specified duration (e.g., quarterly or half-yearly), postponing the effect on EMIs
Examples of EMI Remaining Unchanged Even After Repo Rate Cut
> Example 1: Home Loan on MCLR Benchmark Mr. Sharma had availed a home loan in 2018 under the MCLR system. When the RBI cut the repo rate by 50 basis points, his bank did not cut the MCLR immediately. Consequently, his EMI remained the same until the next reset period after six months, when a marginal cut was made.
> Example 2: Fixed-Rate Car Loan Ms. Priya took a car loan in 2021 at a fixed rate of interest of 9%. Despite several repo rate cuts by the RBI, her EMI did not change since fixed-rate loans are not affected by repo rate changes.
> Example 3: Bank Business Loan with Liquidity Problem The owner of a small business, Mr. Verma had a business loan tied to the RLLR. Although the RBI reduced the repo rate, his bank did not reduce its lending rate, citing high cost of operations and liquidity issues, and his EMI remained the same.
What Can Borrowers Do?
> Check Loan Benchmarking: Your loan should be tied to an external benchmark such as RLLR for quicker rate transmission.
> Negotiate with Lenders: Certain banks permit borrowers to change the type of loan or renegotiate the rate.
> Refinance: Shifting the loan to another bank with a lower rate may be an option for lowering EMIs.
> Monitor Reset Dates: For floating-rate loans, keep in mind the reset period to know when EMI cuts can be effective.
Conclusion
A cut in the repo rate does not necessarily result in reduced EMIs for every borrower because of several structural and operational reasons within the banking system. Although monetary policy has an important influence on interest rates, the degree of benefit to the borrower varies depending on loan categories, benchmark linkages, and specific banking practices. Borrowers need to be well-informed and proactive in order to capture the maximum advantages of interest rate movements.
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