What's the Best Way to Use the Repo Rate Cut to Your Advantage?

RBI reduced Repo rate by 25 basis points

RBI announced a repo rate cut and all jaws dropped with confusion. I, for one, wasn’t sure if this was a good thing for my money or whether I should be really worried.

Turns out, I had nothing to worry about. The repo rate cut announced by RBI is one of the best that could have happened to all investors and depositors across the country.

 

Commercial Banks will reduce rate of interest on loans

The gist of this piece of news is simple. Commercial banks will have to reduce their lending rate, that is, the rate of interest charged on loans they give out. This reduction should see the light of day somewhere around April, as per current speculation. There is no evidence to support this prognosis.

What is the good news in the above deduction? Well, the demand for loans will eventually have to increase when the banks reduce their lending rates. In the event that the demand for loans increases, banks will need to have enough funds to supply for the increased demand.

Best time to invest in a fixed deposit

And that’s the good news, the rates of interest offered on fixed deposits will decrease in the future, but right now they are at an all-time high. They will continue to be as long as banks need to gather funds for the predicted drop in lending rates.

Repo rate won’t affect commercial banks at least for a few months

That’s more interesting is the fact that commercial banks don’t borrow all of their money from RBI, instead they pick up funds from the market. This means that RBI reducing its repo rate won’t affect the banks for a few months and hence they will use these months to collect money as deposits for future lending purposes.

It is a good time for depositors and investors to lock in their money and opportune interest rates.

How much to deposit into a fixed deposit account?

Depositors can consider dividing a sum of say Rs.5 lakhs into 5 separate deposits of Rs.1 lakh each in order to enjoy maximum returns on their investments.

What about debt investors?

Debt investors, especially, should invest in medium to long term funds for maximum benefit.

Dual opportunity in debt

In fact debt offers a dual opportunity with the reduced repo rate coming into play.

On one hand, capital appreciates from easing yields and other the other hand, credit opportunity from improved corporate fortunes.

Word of caution though, a minimum 2 years have to be set aside for both to come to pass.

What happens to rate sensitive markets with the reduced repo rate?

Another question that is interesting is, how does the repo rate cut affect the rate sensitive sectors?

The year that is coming up is good for rate sensitive sectors like, capital goods, auto and banking. They will do well with the reduced repo rates in the next 12-15 months.

What about loans taken that can be invested into fixed deposit accounts?

For those who are looking to pick up loans in order to use this opportune time for investments, a word of advice.

It is best to take loans on floating rates of interest right now. The EMI on such loans will come down substantially when commercial banks employ the reduced rates of lending.

Effect of RBI Rate Cut on Indian Banks in the Short Term

After the recent rate cut of 25 basis points (bps) by the Reserve Bank of India (RBI), banks may find it difficult to cut their lending rates over the short term, according to Pradeep Kumar, Managing Director of the State Bank of India (SBI).

The rate cuts from RBI were initiated after a prolonged period of inflation control by the apex bank. Going ahead in the same direction, Mr Raghuram Rajan, the present Governor of RBI, may cut rates by a further 50 basis points in the current calendar year.

 According to Mr Kumar, SBI and other major banks had already anticipated such rate cuts, and accordingly reduced their deposit rates long before the rate cut was officially announced by the RBI. Also anticipating future falls in rates, customers have been shifting to fixed deposits from their savings deposits so as to ensure steady flow of interests.

In such a scenario, banks like SBI have found it difficult to get their cost of funds to decrease in spite of the lowering of deposit rates. In fact, during the last financial quarter, SBI reported a rise of 1 basis point in their cost of funds. As such, initiating rate cuts in the short term may prove difficult for banks. However, if the inflationary and rate cut trends continue, then all banking institutions will have to relook their rates.

As of now, only United Bank and Union Bank have decreased the base rates since RBI’s repo rate cut in January. The State Bank of India, however, had reduced deposit rates in July last year by around 25 to 50 bps in selected categories. There being a tilt in credit demand as well as availability of excess funds, have inspired some banks to cut deposit rates over the last two financial quarters.

The credit demand, according to Mr Kumar, hasn’t seen change in the ground level. And in absence of new policies that create new assets and large projects, there cannot be improvements in credit demand. Weak demand has also caused large banks to post flat growth figures in the corporate credit sector. ICICI bank, for instance, posted flat figures of 4% year-on-year growth in December.

Mr Kumar has also commended SBI for its system of stress recognition, which helps in identifying Non Performing Assets (NPAs) when a related event happens. SBI currently has one of the lowest restructured assets and NPAs among public sector banks in India. This indicates a high level of identification of NPAs very early in their tenures.

Conclusion

●     The falling rates of interest are instigating customers to move to fixed deposits from their savings deposits, thereby keeping the cost of funds constant for banking institutions. This has kept banks from reducing rates further.

●     If there are more rate cuts by RBI in future, then banks are likely to reduce their rates also.