How is the repo rate linked to home loans and auto loans?

The Reserve Bank of India (RBI) has reportedly slashed the key repo rate for the fourth consecutive time in the year 2019. The third bi-monthly monetary policy review for FY 2019-20 concluded on Wednesday with the central bank cutting the repo rate by 0.35% or 35 basis points (bps).

Following the two-day monetary policy committee (MPC) review, the repo rate currently stands at 5.40%. The RBI had already reduced the rate by 25 bps in its previous monetary policy meeting from 6% to 5.75% in June. This is also the third time the central bank has decided to lower its key repo rate during the financial year.

Taking all reductions into account, the RBI has reportedly brought down the repo rate by 110 bps, i.e., 1.10% since January 2019. The repo rate is the rate at which RBI lends funds to commercial banks during events such as a shortage of funds.

In line with the repo rate, the reverse repo rate was also cut by 35 basis points to 5.15% from 5.50% earlier. The reverse repo rate is the rate at which commercial banks lend money to the central bank to regulate the flow of funds within the country.

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The repo rate is directly proportional to the cost of borrowing for commercial banks in India. The higher the repo rate, the higher the cost of credit will be, and vice versa.

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A reduction in the repo rates will allow banks/financial institutions to borrow more funds from the central bank at lower interest rates. This will, in turn, enable banks to pass the benefit of the reduced interest rates on the loans to their customers.

The rate of interest is directly proportional to the Equated Monthly Instalments (EMIs) payable against your loan. The lower the interest rate, the lesser EMI you will be required to pay.

How is the repo rate linked to home loans and auto loans?

Before discussing how the repo rate is linked to home loans and car loans, you need to know about the Marginal Cost of funds based Lending Rate (MCLR). MCLR is the lowest rate below which banks/financial institutions cannot lend loans.

Home loans were earlier linked to the base rate. However, to ensure transparency in the process of borrowing, RBI mandated the linking of retail loans to the MCLR system in the year 2016.

The MCLR is an internal benchmark lending rate set by the bank which is closely linked to the RBI’s key repo rates. Furthermore, MCLR is mainly associated with floating rate housing loans. Hence, any change is the key repo rates will result in banks revising their lending rates.

With the repo rates reduced by 35 bps in the latest monetary policy review, home loan borrowers can expect the interest rates to go down. This will make home loans cheaper for prospective borrowers as well as bring down interest costs for existing borrowers.