RBI hikes repo rate by 25 bps: Experts believe banks to raise rates

Make small pre-payments to reduce interest outgo on loans; depositors may not gain much if inflation rate stays high

It’s time for depositors to cheer, while borrowers will feel the pinch a little more. With the Reserve Bank of India (RBI) raising the repo rate by 25 basis points (bps) on Wednesday, the first time in four years, banks are expected to follow. The signals have already been there for the past few months.  

Since March, banks have been raising their deposit and lending rates slowly but steadily. Last Friday, State Bank of India (SBI), ICICI Bank, Kotak Mahindra Bank, Punjab National Bank and home loan behemoth Housing Development Finance Corporation raised lending rates. “Over the past 45-60 days, banks have been raising rates steadily in response to rising demand for credit and due to tighter liquidity within the system. The trend will continue, depending on the demand-supply for money,” says Shanti Ekambaram, president-consumer banking, Kotak Mahindra Bank. 

Ashvin Parekh, managing partner, Ashvin Parekh Advisory Services, believes banks will raise rates further. “The liquidity problem within the system will hit the cost of funds for the banking sector. So, banks will have to raise deposit rates, and lending rates will follow,” he says. 

According to experts, deposit growth has been a problem. In 2017-18, data from the RBI website shows aggregate deposits grew only 6.7 per cent, lowest in five decades. “Banks haven’t been able to attract deposits because there have been steady inflows into mutual funds, due to good market conditions,” added Parekh.

Abheek Barua, chief economist, HDFC Bank, believes this could be the beginning of a rate hike cycle. “Given the rising inflationary pressures and the possibility of an overshoot above the RBI’s projected path for inflation, we believe this is just the beginning of a rate hike cycle,” he says. He believes there could be at least one more rate hike of 25 bps before the end of the year.  

For depositors, it is good news because they will earn more from fixed deposits. However, as inflation is on the rise, the real return might not rise too much. Invest in shorter-tenure deposits of not more than six months, so that if rates rise further, you can roll-over to higher rates when your current deposits mature.

On the other hand, higher loan rates might pinch. If you are an existing borrower, and your bank has hiked its Marginal Cost Lending Rate (MCLR), your equated monthly instalment might not rise immediately. It will only rise when your MCLR rate resets. So, if your loan is linked to a longer-tenure MCLR (say, six-month), you might feel the impact later, while those who are on a shorter-tenure MCLR (say, one-month) will feel the impact faster. But, higher interest rates within the economy will eventually translate into higher interest rates for you. 

One of the best ways to protect yourself against higher interest rates is to make periodic prepayments of the loan. “This will be a particularly good move for those at the beginning of their loan tenure,” says Adhil Shetty, co-founder and chief executive officer, BankBazaar.com. 

Interest forms a bigger component of your equated monthly installment or EMI in the early stages of your loan tenure. By making part-prepayment, you can maintain or reduce your total interest outgo. For those who are close to the end of their tenure, Shetty suggests not doing anything. “You should simply maintain the loan till the end of its tenure to collect any useful tax deductions,” he adds. Finally, check how your loan rate compares with the best rate available in the market, and try to hop to the latter.