Explained: Why your cost of loan has not reduced despite a repo cut

The repo rate is the rate at which commercial banks borrow money from the RBI. When the RBI cuts the repo rate, borrowing costs of banks decrease.

In theory, this should translate into lower interest rates for borrowers, as well.

However, the actual impact depends on several factors, including the type of loan you have and the way your bank determines interest rates.

How are the interest rates determined?

The interest rates are determined by two important benchmarks: External Benchmark Lending Rate (EBLR) and the Marginal Cost of Funds-Based Lending Rate (MCLR).

EBLR includes benchmarks like the RBI's repo rate, the government’s Treasury Bill rates, or other market rates. Many loans, including personal loans, home loans, car loans, and MSME loans, are also linked to EBLR.

When the RBI reduces the repo rate, it directly impacts these loans, leading to lower interest rates for borrowers. Banks are likely to pass on the benefit of this rate cut to borrowers, either in full or partially, depending on their policies.

On the other hand, MCLR is used to determine interest rates on loans such as corporate loans, SME loans, overdrafts, and certain personal loans. MCLR was introduced by the RBI in 2016 to replace the Base Rate system, aiming to make lending rates more responsive to changes in the RBI's policy repo rate.

Unlike EBLR, MCLR is calculated by individual banks based on their cost of funds, operational costs, and a tenor premium.

While the RBI directly controls the repo rate, MCLR is influenced by a bank's internal factors, which means that even if the RBI cuts the repo rate, banks may not immediately lower their MCLR if they are facing higher costs elsewhere. Therefore, changes in MCLR may not be as immediate as those in EBLR.

In India, loans generally fall into two categories: fixed-rate loans and floating-rate loans.

The interest rate on fixed-rate loans remains constant for a fixed period, often for the entire duration of the loan. Examples of fixed-rate loans include personal loans, auto loans, and most credit card loans. The interest rate is set at the time the loan is taken and does not change throughout the loan term. This means that even if there are changes in the RBI’s repo rate or other benchmarks, the interest rate on fixed-rate loans remains unaffected.

On the other hand, the interest rate on floating-rate loans, however, varies periodically based on external benchmarks such as the RBI’s repo rate or the MCLR. Home loans, business loans, and some corporate loans typically fall under this category. These loans are more responsive to changes in external rates. For instance, when the repo rate is reduced, the interest rate on floating-rate loans may decrease accordingly, making them more sensitive to changes in economic conditions and monetary policy.

So, why have the floating rate loans not changed yet, and when do interest rates get reprised?

Most floating-rate loans are linked to the repo rate, but they do not automatically adjust every time the repo rate changes. This is because these loans are reset at specific intervals, typically every three or six months.

For example, if your home loan is linked to the repo rate and has a six-month reset period, a rate cut in March would not affect your EMI until the next reset date in July, assuming the last reset was in January.

For loans linked to the MCLR, the adjustment is even more delayed. MCLR does not change immediately with a repo rate cut because it is influenced by additional factors, such as the bank's cost of funds and operational expenses.

As a result, loans linked to MCLR will see rate adjustments with a lag, depending on the bank's internal cost structure and reset schedules.

This means that even if your loan is floating-rate, the reduction in the repo rate might not result in an immediate reduction in your EMI.