How does RBI Repo Rate Impacts Loan EMI and Inflation?

What are the Repo rate and reverse repo rate?

I feel:

One need to be responsible while Seeking credit to fulfill their emergency needs or for starting your dream startups or business because over leveraging and not getting the best interest rate may impact your financial health badly.

With this food for thought today we will learn

  • What is Repo Rates?
  • What Is Reverse Repo Rate?
  • How Does Repo Rate impact the Home Loan or Personal Loan EMI?

The objective of this article is to help you become a well-informed credit seeker

Before we jump into the repo rate discussion it is important to first understand a few details about RBI and its primary roles

RBI & Its Role:

The Reserve Bank of India (RBI) which was established in April 1935 is India’s central bank, also known as the banker’s bank.

The Rule book of the Reserve Bank of India(Preamble) defines the following basic functionality

  • Regulating the issue of Banknotes
  • Maintaining price stability across all sectors while also keeping the objective of growth.
  • Modernizing the monetary policy framework to meet economic challenges

Amongst the above-listed roles, RBI has one key responsibility of keeping a tight check on inflation. To manage inflation effectively it resorts to the concept of pulling liquidity out of the market or infusing more liquidity as and when requires. This leads us to the concept of Repo rate and reverses repo rate, which one needs to understand before decoding its impact on inflation.

What Is Repo Rate?

Commercial banks of India like SBI, HDFC, ICICI, Axis, etc, that operate under the guidelines of the RBI source their funds through these typical channels

  • Savings account deposits
  • Current account deposits
  • Fixed Deposits
  • Recurring deposits
  • Bonds & Debentures
  • Borrowing from RBI(their own banks)

Let’s focus on the last source that is RBI. Whenever our commercial banks are looking to raise funds from the central bank, they get the same from RBI against a certain applicable interest rate called Repo Rate. Repo’’ stands for Repurchase Agreement or Repurchasing Option.

So in a nutshell:

A repo rate is nothing but the interest rate the RBI charges commercials banks whenever these banks reach out to them to source in their fund requirement

What Is Reverse Repo Rate?

Unlike the repo rate when RBI is looking to increase liquidity on their part they offer the facility to the commercial banks to deposit their money in RBI treasury against which, RBI pays them a rate of interest called reverse repo rate. RBI encourages this to control the extra supply of liquidity in the market.

In nutshell-

The Reverse Repo rate is the short-term borrowing rate at which RBI borrows money from other banks. RBI uses this method to reduce inflation when there is excess money in the banking system.

Now that we have understood repo rate and reverse repo rate its time to decode how these impact the interest rate on our home loans and personal loans

How does RBI increase in Repo Rate impact the market and Loan EMI?

RBI monitors the market situation in terms of inflation regularly and if the inflation seems to be threatening, RBI tries to play with the repo rate to contain the same. Which directly and indirectly impacts the loan EMI’s that consumers take from BFSI & NBFCs. so how does it plays out?

Negative Impact On Loans : (EMI cost increases)

Well, whenever RBI increases the repo rate by certain basis points (like the recent increase of 50 basis points announced in May 2022. ) the banks who take a loan from RBI get the same at the higher interest rate, which enforces these banks to pass the extra cost burden to the loan seekers like you and me. Banks offloads the impacts of higher repo rate to the existing consumers by charging an extra rate of interest on secured loans like home loan or LAP.

So if you are the one who has taken a home loan or any loans at the floating interest rate, the change of the interest gets applied to your existing EMI and you end up paying more against your running EMI.

Also if you are seeking a fresh home loan or any personal loan, you may get the same at a higher interest rate. This can be largely discouraging for loan seekers(for businesses and consumers both ) as they will refrain from taking such loans at the inflated interest rate.

Positive Impact On Loans : (EMI cost decreases)

Whenever RBI wants to flush more liquidity into the market to boost the economic growth and consumer spending, they try to do so by decreasing the repo rate, which encourages banks to source more loans from the RBI thereby strengthening their liquidity.

Banks use this extra capital and deploy the same into the market by cutting down on their lending rate, thereby making loans cheaper for the consumers. So if you are having a running loan(having floating interest ) you can expect your EMI to get cheaper. Also if you seeking a fresh loan you can expect the rate of interest being offered by banks to be low.

Tip!

If you are seeking a secured loan(like a home loan) always opt for a floating interest rate as it is 1–2 % cheaper than fixed-interest loans and in case the repo rate is slashed by RBI you can get the extra benefit of lower EMI.

Impact Of Repo Rate On Inflation:

  • Repo rates are tools used by RBI to contain inflation. Whenever there is a rise in inflation that seems to be going out of control, RBI hikes the repo rate thereby forcing users to borrow less. Businesses also borrow less due to inflated interest rates by banks and try to cut down on their expenses by slashing salaries.

This impacts user spending and suppresses the demand for goods, which brings down inflation, as producers are forced to slash their good prices.

  • Also, RBI resorts to increasing the reverse repo rate, which encourages banks to deposit their money to RBI thereby suppressing high liquidity from the market, which in turn lowers inflation as banks refrain from lending as they see more benefits depositing the same with RBI.

When banks lend less to businesses and users, less money gets into the pocket of consumers, which leads to less spending and less demand, thereby lowering inflation.

Things You Should Know About Repo Rate impacts On Loans

  • The repo rate impacts your home loans, vehicle loans, and personal loans EMI
  • Whenever there is a slash in the repo rate by RBI, banks are supposed to act as per RBI guidelines to pass the benefit to the consumers, but very often banks don’t do it immediately and take some time to pass the benefit. But if the repo rate has been increased banks rush to pass on the extra burden to the consumers, which is a great irony.
  • As per the Reserve Bank of India’s guidelines, the bank loans linked to the repo rate need to be revisited every three months.

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@pramodAIML

@pramodAIML

Passionate Blogger & Tech Entrepreneur | Founder of FinTech Startup | Write about AIML, DevOps, Product Mgmt & Crypto