The Reserve Bank of India (RBI), in its second bi-monthly monetary meet of FY 2020-21 held on August 6, has decided to keep the key policy rates unchanged with accommodative stance. The pause has come after two consecutive rate cuts - in March and May 2020.
Post the announcement, the repo rate and reserve repo rate remain at 4.00 per cent and 3.35 per cent, respectively.
A status quo on rates could be good news for fixed deposit investors as banks have been continuously cutting rates on deposits for more than a year now. Some FD tenures now fetch lower interest rates than savings accounts.
For borrowers though, a pause on rate cuts by the apex bank, could mean that banks too will pause cutting interest rates on loans.
A likely pause in reduction in FD interest rates
A pause in the repo rate reduction is likely to prompt banks to go easy on cutting fixed deposit (FD) rates. In the month of May alone, the State Bank of India (SBI) has reduced its FD rates twice.With effect from May 27, 2020, one-year SBI fixed deposit is offering 5.10 per cent for general customer and 5.60 per cent for senior citizens.
Those who depend on FDs for fixed and regular income (many of whom are senior citizens) can consider small saving schemes like monthly income account, post office time deposit. For the June-September quarter of 2020, the government kept rates of small savings schemes unchanged from the previous quarter.
Compared with SBI's one year FD, the one-year post office time deposit is offering 5.5 per cent, which is higher by 40 bps.
Other than small saving schemes, senior citizens have other options to choose from. The Pradhan Mantri Vaya Vandana Yojana and Senior Citizens Savings Scheme currently offer more than 7 per cent per annum.
Further, the RBI has launched floating rate bonds which are currently offering 7.15 per cent (which has replaced the 7.75 per cent RBI savings taxable bonds). Do keep in mind that the interest rate on the newly launched bonds will be reset every six months; the first date being January 1, 2021.
Existing borrowers
A) With loans linked to external benchmark
With no cut in the repo rate, borrowers who have loans linked to an external benchmark are likelyto continue to pay the same EMI for now. The factors that can now impact your EMIs are the margin charged by the bank over and above the external benchmark rate and the risk premium.
B) With loans linked to MCLR
As there is no cut in repo rate there will be no downward pressure on the marginal cost-based lending rate (MCLR) due to this factor but the bank can still cut its MCLR due to internal factors. Remember, MCLR is determined both via internal factors such as soucrce of funds and external factors such as repo rate etc.
Further, generally banks offer home loans with reset periods of either one-year or six months. Therefore, 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 on the basis of the interest rate prevailing on that date (i.e., reset date).
As per a recent Economic Times report, SBI is set to shift to a six-month MCLR from the current one-year rate. The bank said this will result in faster transmission of policy rate cuts for borrowers whose loans are linked to the current one-year MCLR.
Borrowers whose loans are linked to MCLR can switch to a loan linked to an external benchmark. They can make this switch by paying an administrative cost. However, financial planners suggest that one should only shift if the difference in the interest ratesbetween the two regimes is more than 0.50 per cent.
C)With loans linked to base rate or BPLR
A home loan borrower whose loan is still linked to the base rate or Benchmark Prime Lending Rate (BPLR) should consider switching to an external benchmark based loan. The new external benchmark loan regime offers better transmission of 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
For new borrowers, this is a good time to take a home loan even if the key policy rate is kept unchanged. While availing a loan linked to an external benchmark, do compare the spread and risk premium charged by the banks over and above the external benchmark, to get the lowest interest rate.
Further, some banks are offering loans linked to an external benchmark which is not the repo rate. As per an RBI report in April 2020, six banks are offering interest rates linked to certificate of deposit (CD) rates, treasury bills etc. According to the RBI, banks can link their loan interest rates 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 remember 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 to the loan interest rate rather than via MCLR.
Another option available with new borrowers (if eligible) is to claim the credit linked subsidy under Pradhan Mantri Awas Yojana (PMAY). Under the scheme, 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.
