RBI Cuts Repo Rate: Is it time to celebrate?

Updated on August 3, 20153 mins read

RBI cut the Repo Rate today, by 25 bps to 7.50%. 1  bps or basis point is equivalent to  0.01% i.e. 1/100th of a percent. This move seems to have been triggered by a combination of the following factors: lower inflationary pressures and commitment to fiscal consolidation. The Central Bank had cut rates earlier on 15th January 2015 by 25 bps to 7.75%. With this second rate cut the rate cycle stands reversed.

Repo rate is the rate at which the central bank of any country (Reserve Bank of India in our case) lends money to other commercial banks in case they are of short of  funds. It is also a tool used by monetary authorities to control inflation (by raising these rates).

If you are a customer, it’s not time to celebrate yet.

The rate cuts announced by RBI can benefit the ultimate consumer only if the banks follow suit and cut their base rates. Base rate is the benchmark lending rate at which banks lend to customers. Most banks wait for the bigger banks, like SBI, HDFC, ICICI and AXIS to take the first step.  The last time the rate cut was announced by RBI, none of these biggies cut their base rates. As a result only 2 banks passed on the rate cut to their customers by cutting their base rates– United Bank and Union Bank. Interestingly, banks have been cutting deposit rates in the last few months without cutting their lending rates. What this means is a customer is getting lesser return on his investments and is paying more for his borrowings.

What happens when Banks don’t cut the base rates?

To put it simply, growth is adversely affected. There is no incentive for long-term investment. Its only when the lending rates start falling that demand for new homes and automobiles pick up. The base rates of most banks have remained unchanged for a while now. With this second cut in repo rates, there is greater expectation that home and auto loan interest rates shall reduce.

Why don’t banks want to pass on the rate cut benefit to consumers?

The RBI Governor wants to look at institutional constraints preventing the banks from passing the rates to the customers. Banks argue that there is a lag period between RBI announcing rate cuts and the benefit being passed on. But this logic seemed to have failed during the higher interest rate cycle when the banks hiked rates soon after RBI announced a rate hike.

Most experts feel that there is room for further rate cuts: at least 25- 50 bps, likely by the end of April. Are the banks going to wait for a further RBI rate cut before finally passing some benefit to the customer? We sure hope not. Let’s wish that the bigger banks with higher margins like SBI and HDFC shall cut rates in the next few weeks and the other banks shall follow.

Cheers to a healthy, financially-stable and comfortable life!


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