RBI’s Rate Pause: A few key pointers for borrowers and depositors

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Published: December 5, 2019 5:31:51 PM

The RBI has kept the repo rate unchanged. What does this mean for the common man and how will this impact deposit and loan interest rates?

RBI policy, repo rate, RBI Rate Pause, key pointers for borrowers, depositors, Bank deposits , PPF, Senior Citizens Savings Scheme, Sukanya Samriddhi SchemeIt’s advisable that investors who rely on fixed income instruments such as fixed deposits for assured returns and liquidity now look at the various alternatives available to them.

To the surprise of many policy watchers, the Reserve Bank of India has decided not to go for a sixth consecutive reduction in the repo rate. The key lending rate, which has fallen by 135 basis points since February 2019, remains at 5.15%. What does this mean for the common man? How will this impact deposit and loan interest rates?

Rates Seen Falling, But Slowly

Despite a fall of 135 basis points in the repo rate, interest rates on loans and deposits have remained sticky. This is because banks find most of their funds through deposits, and since deposit rates have remained sticky, loan rates had too, and had therefore not fallen sharply in tandem with the repo rate. However, from October 1, interest rates are being linked to external benchmarks such as the repo rate, and this is finally seen to be having an impact in lowering interest rates. In 2018, the RBI had asked banks to link interest rates on commercial loans to an external benchmark such as the repo rate or the Treasury Bill yield.

Share Of Base Rate Loans Decreasing

Earlier, bank loans were linked to the base rate. From April 1, 2016, banks had to move from base rate to MCLR, which as a benchmark was more responsive to rate cuts. But a large quantum of loans continue to be linked to base rate which is notoriously sticky and unresponsive to policy rate cuts. The RBI mentioned that, with MCLR-linked loans since 2016 and repo-linked loans since October this year, the share of base rate-linked loans is decreasing, and this will have an impact in improving the overall transmission of interest rates. As such, borrowers who’re still paying base rate-linked interest rates are advised to look at transferring to a repo-linked loan if the difference is at least of 0.5%, which will ensure large interest savings for them, especially in the case of long-term loans such as home loans.

MCLR Resets Ahead

The RBI mentioned that the one-year median MCLR has declined by 49 basis points. MCLR-linked loans mandatorily have rate resets at fixed intervals such as every six months or once a year. For loans issued between 2016 and 2019, the interest rates are seen happening in a staggered manner, and therefore the resets over the next 10 months will help bring down interest rates further. Of course, borrowers on MCLR-linked loans can skip the line and shift to repo-linked loans.

Deposit Rates Will Fall Further

The RBI reported that the median term deposit rate has fallen by 47 basis points between February and November. But the weighted average term deposit rate fell by 9 basis points in October alone, as against just 7 basis points between February and September. This means that the reduction in deposit rates are likely to quicken, despite the rate pause in today’s review. This means lower returns on bank deposits of various tenures.

Alternatives To Low-Yield Deposits

It’s advisable that investors who rely on fixed income instruments such as fixed deposits for assured returns and liquidity now look at the various alternatives available to them. Bank deposits will return less and less with inflation continuing to remain low despite the latest marginal spike, and so interest rates are also going to be low. Therefore, alternatives such as the Public Provident Fund, Senior Citizens Savings Scheme, and Sukanya Samriddhi Scheme are worth looking into for their marginally higher interest rate offering. Diversifying between various such options will provide depositors with a varied mix of returns as well as maturity tenures.

(The writer is CEO, BankBazaar.com)

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