RBI raises policy rates by 25 bps, Home and Auto loans to get costlier
Oct 25, 2011

Author: PersonalFN Content & Research Team

RBI raises policy rates by 25 bps, Home and Auto loans to get costlier

The Reserve Bank of India (RBI) in its quarterly monetary policy review has raised policy rate by 25 bps or 0.25% on both Repo and Reverse Repo rates.

The anti-inflationary stance by the RBI has led to 13th consecutive rate hike in the last 18 months since March 2010.

The repo rate is the rate at which RBI lends to banks, now stands at 8.50%.

The reverse repo rate at which banks park their surplus with RBI now stands at 7.50%.

While the cash reserve ratio (CRR) remains unchanged at 6%.

This rate hike will make the cost of borrowing costlier for banks, who in turn may pass on the burden in the form of costlier borrowing to the end consumers or loan seekers. Home and auto loan EMIs will increase once banks start raising their base rate, while other loans like personal, education as well as the corporate loans are also likely to become costlier.

On the other hand, the announcement of deregulation of savings bank deposit interest rates (with immediate effect) will bring relief to the savers who maintain a huge surplus into their savings account to meet day to day requirement and contingency needs.

The RBI has however defined a slab of Rs. 1 lakh upto which the banks will offer uniform interest rate on savings bank deposits and provide differential rates of interest for deposits over Rs. 1 lakh. This change will prove beneficial only to people who have and maintain huge surplus into their Savings account and will not benefit the lower income group or a savings account of the earning member of a middle level family.

So suppose you being in a high end bracket maintain a daily balance of Rs. 1,50,000/- into your savings account, then at the rate of 4% p.a. you would have earned a half yearly interest of Rs. 3,000/- over a period of 6 months. Now with the new regulation coming in and say your bank offers interest rate @ 6% p.a. for your deposits over Rs. 1 lakh, then you will earn a half yearly interest of Rs. 3,500/- over a period of 6 months instead.

Your first Rs. 1 lakh deposit @ 4% p.a. will earn you a half yearly interest of Rs. 2,000/- and the next Rs. 50,000/- deposit @ 6% p.a. will earn you a half yearly interest of Rs. 1,500/-. So you earn an additional Rs. 500/- on half yearly basis on your immediate liquidity funds

We at PersonalFN believe that banks will not be always willing to offer higher rates and will prefer offering the differential rates at near 4% fixed level as it will further increase their cost on short term funds. The banks having huge CASA account will keep their focus on current account instead of savings account. The final rate on savings bank deposit offered by banks will be a function of competition between the banks for short term funds.

For people who are seeking for a home loan to buy their dream house or want to take a car loan to buy their dream car will find a hole in their pockets and have to bear a high EMI burden in the near future once the bank start increasing their base rate to set-off their high cost of fund.

The table below shows the impact of 25 bps rate hike by banks on their home loan and auto loan.

Type of Loan	Impact	Loan Amount	Rate of Interest	Tenure	EMI (INR)
Home Loan	Current	30,00,000	10.50%	240 Months	29,951
Home Loan	After Rate Hike	30,00,000	10.75%	240 Months	30,457
Change			0.25%		506
Car Loan	Current	5,00,000	12.50%	60 Months	11,249
Car Loan	After Rate Hike	5,00,000	12.75%	60 Months	11,313
Change			0.25%		64

A 20 year housing loan of Rs. 30,00,000/- borrowed from a bank at an interest rate of 10.50% which has an EMI outgo of Rs. 29,951/- will be increased by Rs. 506/- per month to Rs. 30,457/- once the bank increase interest rates by 25 bps.

At the same time an auto loan of Rs. 5,00,000/- taken at an interest rate of 12.50% for a period of 5 years has an EMI outgo of Rs. 11,249/-. With the hike in interest rate by 25 bps, the EMI amount will move up by Rs. 64/- and the increase EMI will be Rs. 11,313/-.

This rate hike in the form of high borrowing cost will bring an additional burden for people who are already facing the pressure of high inflation. We need to see if this rate hike brings inflation under control or the deregulation of savings account interest rate helps bring down inflation by limiting the flow of surplus funds into the system. If the inflation monster continues to be way above the 9% mark (WPI inflation for September 2011 was at 9.72%) which is much above the central bank's comfort level of 5%-6% the RBI won’t feel any hassle in raising policy rates further. We need to look at the inflation number for the month of October 2011 and other economic growth indicators to judge the further move by RBI in its next mid quarter monetary policy meeting.