Post a rate cut, the newspapers are usually filled with reports on how home loans and other loans are set to become cheaper. While this brings some amount of joy to the reader, most of us remain sceptical. The main question that looms large is, “How much of the rate cut is actually going to be passed on to the home buyer?”
In the current calendar year, the Monetary Policy Committee (MPC) in India has reduced the repo rate by 135 basis points (bps) to 5.15 per cent. It has also indicated that there will be sufficient liquidity in the system to spur credit growth. Post the recent rate cut, the MPC highlighted that they expect the GDP to grow at 6.1 per cent for FY20 from an earlier projection of 6.9 per cent. This is a massive reduction of 80bps. While maintaining an accommodative stance, the RBI also mentioned that inflation is expected to remain benign and range between 3.5-3.7 per cent for 2HFY20. Globally, central banks are reducing rates to spur economic growth.
However, is the transmission of lower rates, from the banks to the general public really happening? Since February 2019, lending institutions have lowered deposit and lending rates by a mere 30bps. Market participants expect another 25-40bps cut in the deposit or lending rate over the next 3-6 months. The RBI has also issued circular guideline to all banks to adopt an external benchmark for deciding applicable rates for loans.
Since October 1, 2019, banks have moved to external benchmark-based lending rates for new floating rate retail, as well as, SME loans. External benchmarking of floating rate loans will lead to faster cuts. In a falling interest rate environment, while this can lead to a faster downward shift in bank rates, banks are taking measured approaches to protect margins. A lender may choose to review the home loan rate on a quarterly basis or some banks may set higher rates such that post-the-reset they will be able to maintain the margin.
For example, SBI had set a lower floor rate of 8.2 per cent for housing loans. This may apply to 20-30 per cent of its housing loans and the rest would be on higher rates; rates will be reviewed on a quarterly basis so there is headroom to adjust spreads for new borrowers. Other banks may also follow suit. If the differential between the current loan rate and prevailing rate is high, it is advisable to re-negotiate the existing loans. After all, a penny saved is a penny earned.