The Reserve Bank of India (RBI) slashed the repo rate by 75 basis points (bps) in its recent update as an emergency measure to protect the economy from the effects of the coronavirus spread. And following suit, many major banks have announced a reduction in their lending rates as well. While a reduction in lending rates in the economy will clearly benefit loan takers, it also hits those living off income from fixed deposits when the rates on these go down. So, it would be interesting to see how this rate cut will impact fixed deposit (FD) investors and loan borrowers, both existing and new.

Interest Income From FDs Likely to Fall Further

In line with the reduction in key rates, recently, the State Bank of India (SBI) reduced interest rates on fixed deposits (FD). The interest rate cut has been sharper for short-term tenures, i.e., up to 179 days by 50-75 bps. However, for longer tenures, the bank cut rates by 20 bps. The new rates came into effect from August 1.

Latest SBI FD Interest Rates for General Public Effective, 28 March 2020

Fixed Deposit Tenure	Interest Rates
7 days to 45 days	3.5%
46 days to 179 days	4.5%
180 days to 210 days	5%
211 days to less than 1 year	5%
1 year to less than 2 year	5.7%
2 years to less than 3 years	5.7%
3 years to less than 5 years	5.7%
5 years and up to 10 years	5.7%

The latest rate cut is likely to cause more heartache for FD investors, especially senior citizens who are dependent on interest income. 

According to reports, this is the first time that the SBI’s fixed deposit rates have fallen below 6% since August 2004, following the directions of RBI. Thus, the rest of the banks will also follow the league and will reduce their FD rates in the future, which is obviously not a good sign for existing and new depositors/investors.  

What should fixed income investors should do now- Where should they invest?

Those investors looking for fixed income avenues can consider investing in small saving schemes as an option. These include:

• National Savings Certificates (NSC)
• Kisan Vikas Patra
• Post Office Term deposits etc. 

At present, these schemes are earning more than FD rates offered by some of the big banks.

Further, if you are looking for a fixed income avenue, now is the right time to consider small savings schemes as interest rates on these products are due for review on March 31, 2020. There is a likelihood that interest rates on small savings schemes will be reduced given the current state of the economy. However, remember that most of the higher yield small saving schemes come with long lock-in periods.

Impact of the Rate Cut on Borrowers

The unexpected rate cut is likely to reduce equated monthly installments (EMIs) of borrowers, and also make it cheaper to take new loans.

Existing Borrowers

• With Loans Linked to External Benchmark

Borrowers whose loans are linked with an external benchmark.i.e.,the  repo rate, treasury-bills, etc as mandated by the RBI can expect to see their EMIs coming down in the next three months. This is because as per RBI’s circular on linking of loan interest rates to an external benchmark dated September 4, 2019, the rates have to be reviewed and reset by banks at least once every three months. 

Therefore, today’s rate cut will lower a borrower’s EMI outgo in the next three months. This is the second time RBI has cut the repo rate after the new lending rate regime came into effect from October 1, 2019.

• With Loans Linked to MCLR

Talking about personal loans, they are usually linked with MCLR, and SBI being a pioneer in this regard has changed the rates immediately. And, offers personal loans-linked with 2-year MCLR. 

Here’s an example of how your personal loan is likely to be impacted under the new MCLR regime.

Particulars	Previous Scenario	Current Scenario
Previous Interest Rates	10.45% per annum	10.35% per annum
Loan Amount	20 Lakh	20 Lakh
Tenure	5 Years	5 Years
Previous EMI	42,938	–
New EMI	–	42,839
Yearly EMI Savings	Rs.1,188 (99×12)

However, borrowers whose loans are linked to the marginal cost-based lending rate (MCLR) will benefit only when their bank reduces loan rates. This is because MCLR is dependent on not just external factors such as rate cut but also on the internal factors of the bank. Further, the reduction in MCLR will translate into lower EMIs only when the reset date of your home loan arrives. Recently, SBI reduced the MCLR by up to 15 bps, which now stands at 7.95% from 8.05% with effect from March 10, 2020.

However, if you want to switch from an MCLR-based loan to an external benchmark one, then you can do this by paying an administrative cost. However, financial planners suggest that one should make a switch only when there is a huge difference in the rates as marginal difference won’t create any impact on your EMIs. 

• With Loans Linked to Base Rate or BPLR

Borrowers whose home loan is still linked to the base rate or Benchmark Prime Lending Rate (BPLR) should consider switching to an external benchmark based loan. The new external benchmark loan regime offers better transmission of policy rates in comparison with a base rate and BPLR rate-linked loans, as per financial planners and industry experts.

What’s in Store for New Borrowers

The latest rate cut will make taking new loans cheaper. While availing a loan linked to an external benchmark, do compare the spread and risk premium charged by the banks over and above the external benchmark, to get the cheapest interest rate.

Also, keep in mind that when RBI starts to hike key rates, your interest rates will go up in tandem. So external benchmark linked interest rates are likely to be more volatile than the MCLR linked rates.

Conclusion

The borrowers can avail the rate cut benefits by enjoying the reduced repayment burden. Whereas, no good news for fixed deposits, especially  senior citizens who are dependent on interest income. Thus, if you are looking for a fixed income avenue, you are advised to invest in short-term saving schemes like- National Savings Certificates (NSC), Kisan Vikas Patra, Post Office Term deposits, etc. At present, these schemes are earning more than FD rates offered by some of the big banks.