By Sharath Pareddy


We often hear that “Inflation is rising/going down” or “RBI increased/lowered the repo rates”. But, what is repo rate? Repo Stands for repurchasing option or repurchasing agreement and is set by the Reserve Bank of India (RBI). It is the rate at which commercial banks borrow funds from the RBI against the collateral of securities so that they can lend loans to their customers.


Why Does RBI Change Repo Rates?


India’s economy is sensitive to changes in the repo rate. It has a direct impact on several aspects of the economy like inflation, growth, currency exchange rates, and others. To help grow the economy in a healthy way, RBI uses the repo rate as a key tool.


Historically, Repo rates in India peaked in 2008, followed by another peak in 2014 and currently, it has been on an increasing trend over the last year, where it changed from 4 per cent to 6.5 per cent. It is an increase of more than 50 per cent within just 12 months. As a result, we have been seeing that banks increase their interest rates on various loan products like home loans, vehicle loans, gold loans, and personal loans.


How Do Repo Rate Changes Affect The Common Man?


Banks have their interest rates tied to repo rates. As RBI changes repo rates, our interest rates change, thus affecting end customers or borrowers in the form of EMI or tenure of the loan.


Loan borrowers might see that their EMI amount isn’t changing but will end up seeing that their tenure is getting extended to a high degree when repo rates increase, thereby resulting in a change in the overall EMI customer pays to the bank. This is because banks do not change the EMI by default, thereby resulting in an increase in tenure.


Customers generally do have the option to change EMI and thereby keep tenure the same. While there are different opinions on which is a better option, the net impact on customers is that overall EMI paid will increase because of an increase in the repo rate.


A small percentage of India’s population is eligible to get a loan from banks. Eligibility is based on their employment, income, historical repayment behaviour, etc. The majority of Indians have loan requirements but cannot manage to get loans from banks.


How Do Underbanked Customers Get Loan Support?


That's where Non-Banking Financial Corporation (NBFC) play a crucial role by providing credit and financial services to a wide range of borrowers, including individuals and small businesses.


How Do Repo Rate Changes Impact NBFCs?


Like banks, NBFCs do not have their interest rates directly tied to repo rates. However, the repo rate has a direct and indirect impact on the cost of funds of NBFCs and hence NBFCs generally pass on higher interest rates to their customers when repo rates increase.


As a result, customers of NBFCs get impacted by Repo rates too. These impacts are felt by individuals, businesses, and other entities that rely on NBFCs for various financial services.


Below are a few examples:



  • Expensive Borrowing: NBFCs may pass on the higher cost of borrowing to their customers. This means that individuals and businesses looking to secure loans from NBFCs will likely face higher interest rates on their loans, making borrowing more expensive.

  • Impact on EMIs: For existing borrowers with variable interest rate loans, such as floating-rate home loans or personal loans, an increase in the repo rate can result in higher Equated Monthly Installments (EMIs). This increased financial burden can affect the monthly budget of borrowers.

  • Loan Repayments: Higher interest rates can lead to increased monthly loan repayments for borrowers, which might strain their finances. This can affect the ability of individuals to take out new loans or make timely repayments on existing ones.

  • Refinancing Challenges: Borrowers with existing loans from NBFCs may find it more challenging to refinance their loans at lower interest rates if the repo rate has risen. This can limit the options available to borrowers seeking to reduce their interest rate burden.

  • Business Expansion: For businesses that rely on NBFCs for financing, higher interest rates can impact their expansion plans. Increased borrowing costs can lead to reduced investments in new projects and potentially slower business growth.

  • Savings and Investments: On the flip side, higher repo rates can result in better returns on fixed-income investments, such as fixed deposits and bonds. This can be a silver lining for customers looking to grow their savings, as they may receive higher interest income from these investments.


(The author is the Head of Credit and Analytics - India at Branch International)


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