ATM :: Tricks banks play with your home loan EMIs

When Reserve Bank of India increases repo rates banks are prompt to pass it on to borrowers, but fail to pass on the rate cut benefits
Khyati Dharamsi | Tuesday, 6 October 2015 – 6:35am IST | Agency: dna | From the print edition


Have you been planning ways to divert the amount saved on equated monthly installments made as a result of the repo rate cut of 0.50% announced by the Reserve Bank of India (RBI)? Have you been elated as your home and car financier announced rate reductions too with effect from October 2015?

Your EMI-saving dreams may be shattered if you take a peek at the rate reductions announced by banks. Since 2010, when the base rate was introduced, banks have passed on almost the entire increase in repo rate to customers, but they have been reluctant to reduce base rates when the RBI has reduced repo rates. Repo rate is the interest rate at which the RBI lends to other commercial banks, while base rate is the rate below which a bank cannot lend.

During 2015 when RBI reduced repo rates on four instances to the tune of 1.25%, banks have reduced rates marginally by 0.60-0.70%.

The RBI too remarked in its Fourth Bi-monthly Monetary Policy for the fiscal, stating, “Markets have transmitted the Reserve Bank’s past policy actions via commercial paper and corporate bonds, but banks have done so only to a limited extent. The median base lending rates of banks have fallen only about 30 basis points despite extremely easy liquidity conditions. This is a fraction of the 75 basis points of the policy rate reduction during January-June, even after a passage of eight months since the first rate action by the Reserve Bank.”

While the RBI publicly announced the lower transmission of rate cuts only during the calendar year 2015, we studied the behaviour of five major banks in response to repo rate cuts and hikes ever since the base rate was introduced in July 2010.

In 2012, the repo rate was cut 0.50% to 8%. Banks, however, reduced the rates only to the tune of 0.25%, barring HDFC Bank, which had slashed its rates by 0.30%. In 2013, the RBI had reduced the rates by 0.75% after increasing then by 0.50% earlier. This was a net reduction of 0.25%. But three out of the five major banks increased their rates by 0.25-0.30%.

In contrast, when the RBI has increased repo rate, banks have been very prompt to pass on the rise.

Between calendar years 2010 and 2011, RBI increased the repo rate on 10 instances to the extent of 3%. Acting in tandem with the rate hikes, five major banks increased base rate to the tune of 300-275 bps. But in 2012, when the repo rates were reduced by 50 bps on April 17, 2012, banks slashed the base rates by 25-30 bps over tranches, some reduced the rates toward the fag end of the calendar year.

Similarly, banks have been prompt in reducing deposit rates too. “Bank deposit rates have, however, been reduced significantly, suggesting that further transmission is possible,” RBI remarked on September 29, 2015.

The peak repo rate of 8.50% was notched on October 25, 2011. The rates have been reduced by a net 1.75% since. But if one compares the net reduction in base rates, the average comes to 0.73%, with the highest reduction being 1.15% and the lowest being 0.25%. Couple of banks still have their base rates the same level as seen in October 2011.

Though the base rate was considered to have an edge over the benchmark prime lending rate methodology followed earlier in transmitting monetary policy effectively, the banks have failed to pass on the benefit of rate cuts to the end borrowers.

But why do banks hold on to rates?

Vipul Patel, founder of Mortgage World, an advisory on loans, says, “Each bank is has a different method of calculating the base rate – some adopt the average cost method, while other use the marginal cost method. There is hardly any impact when the central bank announces a rate cut as a result of this anomaly.”

The scene is set to change with the RBI notifying the draft regulations on the new base rate proposing a shift to marginal cost of funds by April 2016. The motive said the central bank was, “Base Rates based on marginal cost of funds should be more sensitive to changes in the policy rates. In order to improve the efficiency of monetary policy transmission, the Reserve Bank will encourage banks to move in a time-bound manner to marginal-cost-of-funds-based determination of their Base Rate’.”

The final guidelines are likely to be issued by end November 2015. As a result, bank base rates could fall further, say experts. “Things should change with the new policy coming into force. The RBI called all bank chiefs and has mandated banks to pass on the benefit of the rate cut. I see a big discount coming into effect. Overall, the rates should be in the range of 9%.” says Patel.

If your bank doesn’t reduce the interest rate then one should consider a shift as even a 0.25% difference in the interest rate can result in a saving of six EMIs if your home loan tenure is 15 years, while seven EMIs on a 20-year home loan tenure.

But before you shift the loan to another bank, be careful of moves such as a lower reduction for new borrowers (0.20% difference) similar to what the State Bank of India has proposed.

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