RBI Annual Credit Policy 2009-10: Impact

In its Annual Credit Policy on Tuesday, the Reserve Bank of India (RBI) announced a cut in repo rate — the rate at which the RBI lends short-term funds to banks — and reverse repo rate — the rate at which banks park surplus funds with the RBI — by 25 basis points each (i.e., 0.25 % , 1 percentage point is equal to 100 basis points). This move is meant to encourage banks to undertake more lending and at the same time maintain pressure on the interest rate charged on loans. This is the seventh time the RBI has cut rates since September 2008. In this period, the RBI has reduced the repo rate from 9% to 4.75% and the reverse repo rate from 6% to 3.25%.

Impact on Loans and EMIs

This rate cut is meant to send out a strong signal to banks to follow suit and slash their rates. This will drop EMIs further and there will also be a dip in the interest received from bank fixed deposits. Given the low rate of inflation, there was a need to reduce interest rates and according to the RBI’s calculation, the prime lending rates of banks should be cut by at least two percentage points to 10% from the current level of 12% (for public sector banks ). After the RBI’s announcement, ICICI Bank immediately reduced its floating reference rate and benchmark prime lending rate by 50 basis points each to 13.25% and 16.25%, respectively. Yes Bank also cut its PLR by 50 basis points. Interest rates on all floating rate home loans of the existing borrowers are also expected to come down by the same point.

Depositors

Depositors are tipped to earn better returns on bank savings accounts in the future with the RBI altering the calculation of interest earned on such deposits. In its annual policy statement for the FY 2009-10, the RBI has instructed banks to calculate  interest on savings accounts on a daily basis. Currently, banks calculate the interest based on the minimum balance held in savings accounts from the tenth to the last day of each calendar month. Since interest is paid only on the minimum balance, the effective return to the depositor works out to around 2.9%, which is way below RBI’s mandated 3.5% rate. Once banks start offering interest on the balance maintained on a daily basis, the effective return will be between 3.25% and 3.5%.

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