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Repo rate is the rate at which the Reserve Bank of India (RBI) lends money to commercial banks. Repo rate stands for “Repurchase Rate”. Repo rate indicates the rate at which RBI offers credit to commercial banks, against collateral such as government securities. The agreement is to repurchase these collaterals at a future date at a fixed price. CRR is the portion of deposits made my commercial banks to the RBI.
A cut in Repo rate will lower the cost of borrowing for commercial banks as well as for individuals. The rate at which banks offer credit such as personal loans, home loans, etc. is called the cost of credit. The interest on loans are alternately reduced. This will also lead to a reduction in CRR (Cash Reserve Ratio) which would increase the availability of credit to individuals.
Example, if the repo rate is 5% and the loan amount that the bank has availed from the RBI is Rs. 1000, then the interest paid out by the bank on the same would be Rs. 50. Therefore, a lower repo rate indicates lower interest rate charged on loans availed from these banks by regular customers.
Repo Rate cuts influence the lending rate or rate of interest on all mortgages such as personal loans, car loans, housing loans, etc. This reduction in the rate of interest is expected to increase demand for these products. A reduction in the Cash Reserve Ration would enhance the availability of funds and bring in more liquidity to the banking system. This will alternately affect the economy as well, which is one of the reasons why RBI introduces such a change.
However, it is important to note that repo rate cut would lead to a reduction in the rate of interest only if the loan has been offered on a floating interest rate basis. If the personal loan has been offered on a fixed interest rate basis, then the interest rates would not be affected by any changes in the repo rate. Therefore, repo rate cuts will benefit new personal loan borrowers when the banks implement the changes but existing borrowers who have opted for the fixed rate of interest would not benefit from the same.
The other side of the coin is an increase in repo rate. When repo rate is increased by the RBI, the commercial banks have to pay more for the money borrowed from RBI. Alternately, these banks would increase the interest on loans offered to the public. This only impacts loans offered on a floating rate of interest.
The CRR cut causes a long-term impact on personal loan products. The interest rates are lowered with repo rate cuts. The cost of borrowing would reduce drastically for both corporates as well as individual customers. With a reduction in lending rates, personal loans will become more affordable for borrowers. However, it is also essential to have a moderate transmission in the rate of growth of credit. Otherwise, the overall effect of the repo rate cut will stay neutral.