Explained: RBI's rate cut and its impact on fixed deposit investors and borrowers
Last week, the Reserve Bank of India (RBI) cut the benchmark repo rate, the rate at which the RBI lends to other banks, by 25 basis points from 6.50 per cent to 6.25 per cent. This is the first rate cut initiated by the RBI since 2020. Although the banks are yet to revise the rates, it will impact both the depositors as well as borrowers. While the possible rate cut may bring some relief to borrowers in near future, depositors, especially fixed deposit (FD) investors, are bound to get lower returns on their investments.
How rate cut could impact customers
When the repo rate is cut or lowered, banks can borrow funds from the RBI at a cheaper rate. This allows the banks to pass on the benefits to borrowers through reduced interest rates. However, interest rates differ from bank to bank. While some banks may pass on the full benefit to borrowers, others may transfer only a portion. On the other hand, lower interest rates also lead to a drop in deposit rates.
What does this mean for fixed deposit investors
Though interest rates are expected to come down with the latest rate cut, people who rely on fixed deposits for income will get lower returns. So, if banks reduce interest rates, new FD investors will earn less than those who invested at higher rates earlier.
Experts suggest that FDs remain a safe option to lock in deposits at a higher rate. Since the rate cut by banks is likely to be announced soon, if a customer plans to open a new FD, they should lock in the current higher interest rates as soon as possible.
For example, some banks, especially small finance banks, offer interest rates around 9 per cent. So, if you lock in that rate and later on if the rates drop, you will be insulated as you will still earn 9 per cent on your fixed deposit. So, once invested, the money cannot be withdrawn before maturity without a penalty.
What does this mean for borrowers
Large commercial banks usually adjust their rates more quickly than small finance banks, which may take longer to revise their offerings. With rate cut on the cards, borrowers with floating interest rate loans will benefit the most. Majority of the banks link their loans to an external benchmark rate, such as the RBI’s repo rate. So, in case of repo rate cut, banks get an opportunity to borrow funds from the RBI at a cheaper rate. While some banks may pass on the full reduction in interest rates, others might transfer only a portion, depending upon their individual’s policy.
According to experts, especially, borrowers on flexible rate loans linked to the repo rate such as home, auto and personal stand to gain from the rate cut.
So, the existing home loan customers would have option to either reduce their EMI or the tenure. If a customer is comfortable in paying existing EMI, then paying that amount further won’t be a challenge. In that case, he would be able to pay his debt early than the agreed. So, the best practice is to get one's home loan tenure reduced. In other case, he can request the bank to reduce his EMI, keeping the tenure same as signed in the original agreement.
However, for fixed-rate loans, the decision to lower interest rates rests with individual banks, meaning some borrowers may not see an immediate reduction in their EMIs.
