RBI policy effect: Loans to get more expensive as banks hike lending rates

Following the monetary policy committee’s (MPC) decision to raise benchmark policy rate by 50 basis points, many lenders, including ICICI Bank and Bank Baroda have raised their external benchmark linked loan rates by an equal amount.

ICICI Bank on Thursday raised its external benchmark lending rate by 50 basis points to 8.60 per cent while Bank of Baroda has increased its repo linked lending rate to 7.40 per cent. RBL Bank has also raised its repo-linked lending rate by 50 bps to 10 per cent, effective June 8, 2022. Another private sector lender, Federal Bank, has also factored in the increase in and increased the interest rates accordingly.

On Wednesday, the six-member MPC raised the for the second time in as many months by 50 basis points to 4.90 per cent. Since May the has been increased by 90 basis points by the rate setting body to tame headline inflation which has been consistently over the 6 per cent threshold.

In May, the rate setting body raised the repo rate by 40 basis points in an off-cycle meeting, thus ending the days of ultra-loose monetary policy and officially starting the tightening cycle.

Economists expect there could be a rate hike in the August monetary policy too and even in the October policy, thereby taking the repo rate to 5.5 per cent by October.

““…with EBLR linked loans gaining traction, repo rate increase will curtail inflation through the credit channel as well. As every 1 bps increase in repo has combined impact of Rs Rs 305 crore on demand from Retail & MSME Consumers, with terminal repo rate at 5.75 per cent there will be reduction in demand from consumers to the tune of Rs 45,000 crore”, said Soumya Kanti Ghosh in his report.

Generally, an increase in the benchmark repo rate augurs well for banks because they benefit from higher yields on the lending portfolio linked to external benchmarks and with no cash reserve ratio hike this time, lender’s may have a positive impact on their margins.

As of December 2021, a little over 39 per cent of bank loans, including 58.2 per cent of home loans, are linked to the external benchmark, shows the (RBI) data. The share of micro, small and medium enterprises, personal loans, vehicle loans, and education loans linked to the external benchmark are 69.2 per cent, 46.2 per cent, 31.1 per cent, and 23 per cent, respectively, the RBI data showed.

The RBI mandated the introduction of an external benchmark system of lending for select sectors in October 2019. Any change in the benchmark rate is mandated to be passed on to lending rates for new and existing borrowers on a one-to-one basis and banks are restricted from adjusting their spreads for existing borrowers for three years in the absence of any significant credit event.

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