Lending rates set to rise; interest rates on deposits may also move up

The days of ultra-low interest rates are over. With the monetary policy committee (MPC) raising the repo rate by 40-basis points to 4.40 per cent on Wednesday, the interest rate cycle has turned.

Consequently, lenders will revise their lending rates upwards, especially on loans, which are linked to an external benchmark.

Interest rates on deposits are also expected to move upwards, bringing some relief to the common man.

As of December 2021, a little over 39 per cent of loans by banks are linked to the external benchmark, shows Reserve Bank of India (RBI) data.

And, 53 per cent of loans of the banking system are linked to the marginal cost of funds-based lending rate (MCLR).

Further, as much as 58.2 per cent of the home loans are linked to external benchmarks. In the case of MSME loans, personal loans, vehicle loans and education loans, they are 69.2 per cent, 46.2 per cent, 31.1 per cent and 23 per cent, respectively.  

The RBI mandated the introduction of an external benchmark system of lending rates for select sectors in October 2019.

This meant any change in the benchmark rate was mandated to be passed on to the lending rates for new and existing borrowers. And, banks are restricted from adjusting their spreads for existing borrowers for a period of three years in the absence of any significant credit event.

“The entire book linked to the repo rate gets re-priced immediately. The MCLR-based book had already started moving up. As the cost of funds goes up, it will be transmitted to the borrowers. I think we have to be fair. Banks are basically converters. Therefore, our deposit rates will go up and to that extent, savers will benefit. We have to look at this in a balanced way. There seems to be a tendency to look at it from a borrower’s point of view. The savers have been screaming for two years that they are getting negative real returns. So, I am glad that savers will be taken care of as we go forward,” said Uday Kotak, managing director (MD) & chief executive officer (CEO), Kotak Mahindra Bank, to CNBC TV18. 

“With MPC raising rates by 40 bps, there will be some impact on the lending rates. The ALM committee will meet in a few days and decide on the rates. I had earlier said MPC will raise rates by 75 bps this year, it seems they have frontloaded that with a 40 bps hike on Wednesday. I still feel rates will go up by another 35 bps in this year, however, a lot will depend on the global factors,” said Keki Mistry, vice-chairman & CEO, HDFC Ltd. 

The repo rate was hiked for the first time since August 2018.

As the pandemic hit the country, the MPC reduced the repo rate by 75-basis points, and subsequently, cut it by another 40-basis points. This took the repo rate to 4 per cent, as it entered the ultra-accommodative mode to tackle the ill-effects of the pandemic.

The RBI also injected liquidity facilities to the tune of Rs 17.2 trillion during the pandemic, of which Rs 11.9 trillion was utilised.

Consequently, due to the ultra-accommodative monetary policy stance and excess liquidity in the system for the last two years, interest rates for loans were at an all-time low.

Many lenders had been offering mortgage loans of as low as 6.5 per cent.

With rising domestic inflation, accentuated by the geo-political tensions, and global central banks tightening their monetary policy as they come out of the Covid era easy money policies, it was a matter of time before the MPC raised rates.

In fact, after the April monetary policy meeting, where the RBI maintained status quo as far as rates are concerned, but shifted its focus more on inflation rather than growth, economists had factored in rate hikes from the June policy.

“We believe that lending rates may go up gradually, and since there is enough liquidity in the system, our borrowing cost may go up only gradually. Most of the borrowing for us is fixed in nature and hence the rate hike will not have any immediate impact on borrowing cost,” said Umesh Revankar, vice-chairman & MD, Shriram Transport Finance.

“The rate hike’s impact would be felt across all categories of loans — from home to auto to personal loans, both secured and unsecured. A 40 bps will pinch the borrowers, who will shell out more now for their equated monthly instalments (EMIs).  Existing borrowers will see their tenor go up,” said Adil Shetty, CEO, Bank­Bazaar.com.

A home loan borrower with an outstanding principal of Rs 50 lakh and tenor of 20 years at 7 per cent interest could see the tenor extend by 18 months when interest moves up to 7.4 per cent.

“Borrowers who have taken an MCLR-linked loan will also feel the pressure, though it may take a little longer until the borrowers’ loan reset before the new rates come into play for individual borrowers. On the flip side, the rate hike would also translate into higher returns on fixed deposits,” Shetty said.

Last month, State Bank of India increased its MCLR by 10-basis points. Axis Bank and Kotak Mahindra Bank also hiked their MCLR by 5-basis points. Bank of Baroda increased its MCLR by 5-basis points.

“For home buyers, this hike signals an imminent end to the all-time low interest regime, which has been one of the major drivers behind home sales across the country since the pandemic began. Moreover, rising interest rates and inflationary trends in basic raw materials in construction, including cement, steel and labour costs, will add to the burden of the residential sector,” said Anuj Puri, chairman, Anarock Group.