You are on page 1of 19

Factors which Impact Loan

Interest Rates
&
How to decide Fixed v/s Floating
Interest Rates?
TakeBestLoans.com

Index
Definitions

Tools available with RBI and their functions

RBI and its tools


Repo Rate and Inflation
Repo Rate and GDP
Conclusion
TakeBestLoans.com

Lets go through some


Definitions
Repo rate Repo rate is the interest rate at which banks borrow money
from RBI. Currently 8%. There is a certain limit up to which banks can
borrow from RBI at repo rate.
MSF rate Marginal standing facility rate is the rate at which banks borrow
from RBI once the borrowing limit under the repo rate is exhausted.
CRR (Cash reserve ratio) Certain amount of cash is to be maintained by
banks to pay up the depositors at any given point.
SLR (Statutory Liquidity Ratio)- RBI decides a certain percentage of total
assets that banks have to invest in low risk government bonds mandatorily.

TakeBestLoans.com

Lets go through some


Definitions
WPI (Wholesale Price Index) - WPI inflation is calculated on the basis of
increase in whole prices of commodities.
CPI (Consumer Price Index) - CPI is the inflation that is met by the end
product or service user. It is the increase in the prices of goods & services
which are witnessed by the common man.
WPI Core - It is the WPI inflation which excludes food, reason being food is
always at the higher end of inflation. Excluding it gives better estimate of
average price changes in commodities.

TakeBestLoans.com

Lets go through some


Definitions
Gross Domestic Production - GDP is the total amount of goods & services
produced within the country. Therefore GDP growth shows overall increase
in the capacity of production of a certain country which can be a measure of
economic growth of a country.
Index of Industrial production - IIP is another measure to estimate economic
progress of a country. It measures the increase or decrease in the production
activity of a country.
Inflation - Inflation is the rise in prices of goods & services. When the
demand for goods & services goes up and supply is not able to keep up with
demand. Prices for goods rise as there is only limited supply. This rise in price
is called inflation.
TakeBestLoans.com

Simple overview about banks and


loans
Before going into details lets get a basic idea of what bank does.
Lets imagine a scenario where you walk into a bank with 1,000 and put the
money in fixed deposit in the bank giving you a 8% interest return. The bank
Lends out that 1,000 to another person seeking finance at a 12% interest
rate. So bank stands to make the 4% additional interest gain, after paying you
8% interest. Thats how banks works. Lets say the 12% is the base rate for
this particular bank.

TakeBestLoans.com

Tools available with RBI and their


functions

Here are the tools Reserve Bank of India (RBI) uses to influence the economy of a
country.
Repo rate- When the economy is bottomed out RBI decreases the repo rate so as to
decrease the base rate of the banks. So lets say the 12% interest rate loan is available
for 10% now. Imagine you have a home loan which had a 20,000 EMI, now it only costs
you 15,000 per month. This hikes the demand for loans as they are cheaper now. Vice
Versa, in a scenario where the inflation in country is high RBI increases the repo rate
which shoots up the base rate of banks. So the 12% jumps to 14%. So your home loans
which cost you 20,000 EMI earlier now costs you 25,000. In this case fewer people
will opt for housing loan as it is more expensive now. Similarly in the economy as whole
demand for goods & services drops down because of less money supply in the
economy. Now fewer people have capacity to purchase commodities without those
costly loans. This results in drop in demand for commodities and thus helps reducing
inflation.
TakeBestLoans.com

Tools available with RBI and their


functions
CRR- According to the RBI guidelines, banks must maintain a certain CRR fixed
by RBI. The motive behind this is that if at any given time more than expected
depositors show up to withdraw their deposits the banks should be able to
generate enough cash to satisfy the demands. Increasing or lowering CRR helps
RBI in maintaining money supply in the economy. Suppose if RBI increases the
CRR, bank would have to keep more cash in reserve with them & thus they
may lend out only lesser.
SLR- Money invested in low risk assets such as government bonds serves the
purpose same purpose as CRR. This can be explained thinking of an extreme
scenario where bank has losses on loan advances and thus cannot pay up the
depositors money. By selling the government bonds banks can come up with
cash to pay off depositors. SLR is also to be maintained by the banks as per RBI
guidelines.
TakeBestLoans.com

Tools available with RBI and their


functions
MSF rate - MSF rate as explained before is the penal borrowing rate which
banks use when they exhaust the borrowing limit under Repo rate.
Increasing or decreasing MSF impacts on the banks base rate. Similar to the
repo rate hiking or lowering the MSF has similar impacts on the base rate of
banks. Therefore its another tool RBI uses to control the money supply in the
market.
Reverse Repo- An increase in the reverse repo means commercial banks gets
more interest when they lend RBI. This results in decrease of money supply in
the market. Vice versa when the economy is strained & RBI wants to increase
the money supply in the market, it decreases the reverse repo rate.

TakeBestLoans.com

RBI and its tools


RBI uses the tools as discussed earlier to control Inflation, GDP and even other
factors.
Repo rate is the most relevant indicator for the determination of bank interest rates.
Repo rate, Reverse repo, MSF, SLR and CRR all these rates mostly flow together.
MSF was introduced in 2011, so the banks can get more money if required and is
supposed to be 1% higher than repo rate, but in 2013 it was 3% because of falling
rupee value.

SLR and CRR are used to control flow of money in the market and for contingency
purpose.
Since 2011 the SLR and CRR has also been decreasing from 24% and 6% to 22% and
4% in 2014 respectively.

TakeBestLoans.com

10

TakeBestLoans.com
Aug 2014

Jul 2014

Jun 2014

May 2014

Apr 2014

Mar 2014

Feb 2014

Jan 2014

Dec 2013

Nov 2013

Oct 2013

Sep 2013

Aug 2013

Jul 2013

Jun 2013

May 2013

Apr 2013

Mar 2013

Feb 2013

Jan 2013

Dec 2012

12

Nov 2012

Oct 2012

Sep 2012

Aug 2012

Jul 2012

Jun 2012

May 2012

Apr 2012

Mar 2012

Feb 2012

Jan 2012

Dec 2011

Nov 2011

Oct 2011

Sep 2011

Aug 2011

Jul 2011

Jun 2011

May 2011

Percentage %

RBI and its tools


RBI Tools
24.5

10
24

MSF

23.5

Repo Rate

23

6
22.5

2
21.5

0
21

11

Reverse
repo

CRR

22

SLR

Repo Rate and Inflation


Inflation has always been a major concern for RBI.
Inflation is calculated on WPI or CPI.
In India, inflation is primarily referenced on WPI, but since 2013 RBI is also closely
following CPI.
WPI neglects the end users, but on the other hand CPI considers end users i.e. the
consumers. CPI is used by majority of the countries.
Therefore, the WPI inflation is lower as compared to CPI, which can be seen the
below graph.

In the graph we can see the repo rate is above WPI through out and repo falls when
WPI goes down and vice versa.

TakeBestLoans.com

12

Repo Rate and inflation


But we can see the WPI is going down but repo rate is constant in the end of 2013
and increased instead of lowering in January 2014 (to control CPI).
CPI and WPI was at 11.16% and 7.75% in November 2013, and started falling
after.
WPI inflation is the lowest since 2011 at 3.74% but RBI is also focusing on CPI, so
in January 2014 the repo was increased to 8% from 7.75%.
CPI inflation has come down and the RBI has set target of 8% till January 2015
and 6% till 2016.
The CPI for August 2014 is 7.8% and RBI expects it to be constant.

TakeBestLoans.com

13

Repo Rate and Inflation


12

10

Repo
Rate

WPI %
4

CPI %
2

TakeBestLoans.com

14

Repo Rate and GDP


GDP growth has not been very good since after 2008
recession. The GDP had grown in 2009-10 and 201011 but since then decreasing again.
GDP growth was recorded the lowest for 2012-13 at
4.47%.
A low Repo rate helps to push GDP up (inverse
relation). This happens because low interest rate will
allow people to borrow and production in India will
increase which will push our GDP up.
GDP and repo rate from September 2008 to February
2009 went down together because of 2008 recession.

2007-08

9.32

2008-09

6.72

2009-10

8.59

2010-11

8.91

2011-12

6.69

2012-13

4.47

2013-14

4.74

0.00

2.00

4.00

6.00

GDP Growth %

TakeBestLoans.com

15

8.00

10.00

Repo Rate and GDP


When the GDP started growing after recession, the repo rate again was low
and GDP % high

Since December 2013 the repo rate has been increased even though there is
slight increase in GDP.
The Reason for not decreasing repo rate is, RBI is more focused on controlling
inflation for the benefit of common man.

TakeBestLoans.com

16

Repo Rate and GDP


Repo Rate & GDP Growth
12

10

Repo Rate %
TakeBestLoans.com

GDP %
17

Conclusion
The bank interest rate will change when repo rate changes.

It is expected that RBI may soon decrease the Repo Rates in 2015 (hence loan
interest rates should also come down eventually in 2015)
So it is currently desirable to go for floating rates rather than fixed rates for
taking any loan.
Besides, there are currently no pre payment penalties for floating rate
housing loans
If you have taken fixed rate loan, when the repo rate goes down (base rate of
bank may reduce and hence also the loan interest rates) you will be paying
the same interest rates (rather than lower interest rates).

TakeBestLoans.com

18

More Info

https://www.takebestloans.com/

DISCLAIMER
All materials, information, products and services are provided "as is," with no warranties or guarantees whatsoever. Information in this PowerPoint, unless specifically promised or warranted to be correct, is not promised or guaranteed to be
correct, current, or complete, and while we make best effort to ensure accuracy of the information, data and content, this PowerPoint may contain technical inaccuracies or typographical errors. We assume no responsibility for updating this
PowerPoint to keep information current or to ensure the accuracy or completeness of any posted information. Accordingly, you should confirm the accuracy and completeness of all information before making any decision whatsoever.

TakeBestLoans.com

19

You might also like