What is a repo rate in a Personal Loan?

imageBorrowers have to repay the personal loan amount to the bank of the financial institutions through equated monthly installments (EMI). It consists of a part of the principal amount and the interest charged on the loan amount. The borrower has to pay the EMI until the end of the loan tenure. A borrower can use the Personal Loan Calculator facility to calculate the EMI they would have to pay. This facility is available on the website or the mobile app of the bank or the financial institution. It allows the borrowers to try various combinations of the loan amount and loan tenure to calculate the EMI; by using this, they can figure out a suitable loan combination according to their financial requirements and repayment capacity.

Repo rate refers to the “repurchase rate”. It is the rate at which the Reserve Bank Of India (RBI) issues money to the commercial banks in the country. It indicates the rate at which commercial banks obtain credit from the RBI against collaterals such as government securities. An agreement between the commercial banks and the RBI exists to purchase these collaterals at a fixed price in the future. The RBI uses the repo rate to control the inflation and deflation of prices in control.

If there is an inflation of prices, the RBI increases the repo rate to discourage the banks and financial institutions from borrowing funds, leading to a reduced money supply in the economy. Thus, the inflation rate would fall.

In contrast, if there is a deflation of prices, the RBI decreases the repo rate, which encourages the banks and financial institutions to borrow funds, increasing the money supply in the economy. Thus, the deflation rate would be balanced out. 

Cash Reserve Ratio refers to the portion of deposits made to the central bank, i.e. the RBI by the country’s commercial banks. A reduction in CRR enhances the liquidity and availability of funds with commercial banks. A reduction in the repo rate by the RBI would lead to an increase in the availability of loans and advances to the banks’ customers. A decrease in the repo rate is beneficial for commercial banks and individual borrowers. If there is a fall in the repo rate, the interest rate charged on the personal loans also falls—a low repo rate results in low-cost loans for the borrowers. When the RBI decreases the repo rate, they expect commercial banks to reduce loan interest rates. Similarly, if the RBI increases the repo rate, the loan interest rates charged by commercial banks would grow as it becomes expensive for them to obtain credit from the RBI.

Due to this, the equated monthly installments (EMIs) paid by the borrowers on the personal loan are affected by the repo rates. The EMI consists of the interest rate charged on the principal amount. If the repo rate decreases, the interest decreases, which leads to a reduction in the EMI paid by the borrower. This helps the borrower in saving money. However, if the repo rate increases, the EMI to be paid would also increase because of the rise in the interest rate.

The borrower should remember that a decrease in the repo rate would only reduce the personal loan interest rate if the interest rate is computed on a floating basis. If the interest on the personal loan is calculated based on the fixed interest rate, the interest rate will remain constant regardless of any change made by the RBI on the repo rate.

At present, the repo rate announced by the Reserve Bank of India is 4.00%. There was a drop in the repo rate by 40 basis points. Before 22nd May 2020, the repo rate was 4.40%. TATA Capital Personal Loan offers personal loans to borrowers at competitive interest rates.