ANALYSIS Rate cut relief comes faster for existing borrowers, as banks adjust spread for new loans

Rate cut relief comes faster for existing borrowers, as banks adjust spread for new loans

Public sector banks have started lowering their lending rates in response to the Reserve Bank of India’s (RBI) unexpected decision to reduce the repo rate by 50 basis points to 5.5 percent.

Private sector lenders, while taking a more cautious approach are, too, gradually following suit.

Leading the charge, major public sector banks including Bank of Baroda, Punjab National Bank (PNB), Bank of India, and UCO Bank have reduced their Repo-Linked Lending Rates (RLLR) by a full 50 basis points.

RLLR is the interest rate at which banks lend to customers, directly linked to the RBI’s repo rate, ensuring faster transmission of monetary policy changes to borrowers. The Marginal Cost of Funds Based Lending Rate (MCLR), on the other hand, is the minimum interest rate that a bank can offer on loans, determined by factors such as the bank’s cost of funds, operating expenses, and required margins, and typically responds more slowly to policy rate changes than repo-linked rates.

Bank of Baroda has cut its RLLR from 8.65 percent to 8.15 percent, effective June 7. Punjab National Bank will bring down its RLLR from 8.85 percent to 8.35 percent, starting June 9, while Bank of India has lowered its RLLR from 8.85 percent to 8.35 percent, effective June 6. UCO Bank has reduced its RLLR from 8.80 percent to 8.30 percent and has also trimmed its MCLR by 10 basis points across tenors.

Among private banks, HDFC Bank has lowered its MCLR across tenures by 10 basis points, effective June 7. Similarly, Karur Vysya Bank has reduced its six-month MCLR by 10 basis points and one-year MCLR by 20 basis points.

However, other major private lenders such as ICICI Bank and Axis Bank have yet to announce any rate cuts.

What is interesting is, this time, the pattern of transmission appears to be skewed toward existing borrowers.

Typically, when the RBI cuts the repo rate, banks respond by lowering lending rates, and the benefits are passed on more quickly to new borrowers to boost loan growth. Meanwhile, existing borrowers, especially those on older lending benchmarks like MCLR or base rate, often see delayed benefits because of periodic reset clauses or structural lags in rate transmission.

However, in the current cycle, the pattern is somewhat reversed as banks have cut their RLLR which is typically in line with the RBI’s 50 basis points repo rate reduction, rather than adjusting the MCLR, which typically responds more slowly.

While adjustments to MCLR have been made by a few private banks, as mentioned above, they have been smaller in magnitude, by 10-20 bps.

Many existing borrowers who have already taken loans linked to the RLLR will likely see immediate relief in their EMIs, since these loans are directly benchmarked to the repo rate and typically reset every three months. So, if your loan is due for reset now, the full 50-basis point cut will reflect in your new EMI almost automatically.

On the other hand, new borrowers may not fully benefit from the 50-bps repo cut because banks are increasing the spread, that is, the additional markup they charge over and above the repo rate. This is done to protect their net interest margins (NIMs), which could otherwise shrink due to falling lending rates.

Moreover, not all loans are repo-linked.

Many borrowers, particularly those who availed loans before October 2019, are still tied to older MCLR-linked or base rate-linked loans. These rates don’t react as quickly to repo rate changes. Borrowers in such categories will not see any immediate reduction in their EMIs unless they formally switch to an RLLR-based product.

Furthermore, while the move is favourable for borrowers, it has implications for depositors.

Banks are expected to cut returns on fixed deposits and other term instruments, in line with falling lending rates and increased liquidity. Motilal Oswal estimates suggest a dip of 30 to 70 basis points in fixed deposit returns across tenures.

While repo-linked loans respond instantly to monetary policy changes, deposit rates tend to adjust more slowly due to regulatory norms and competitive market pressures. As a result, lenders may face margin pressure, the firm noted in its report, over the next two quarters until deposit repricing aligns with the new rate environment.

The RBI’s move, announced on June 6, marks its most aggressive rate cut in nearly five years.

As part of this easing package, the RBI also announced a 100-basis point phased reduction in the Cash Reserve Ratio (CRR), aimed at injecting Rs 2.5 lakh crore into the banking system.

Simultaneously, the RBI also shifted its policy stance from ‘accommodative’ to ‘neutral’, indicating that while supporting growth remains a priority, and further rate cuts will be “contingent on future data,” as noted by Sanjay Malhotra during the press conference on June 6.