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Introduction of the Industry

How RBI rate hike impacts your financial life


40Share Few days back, there were some changes announced in repo rate and saving bank account interest rates by RBI. Do you want to know how you as an investor would get impacted with the recent changes done in interest rates by RBI? I have seen that a common man always ignores this kind of news because it looks too complicated to him or he cant understand how his life will be affected by such fluctuations. In this article, I will touch two most important changes that were recently disclosed by RBI and show you in simple manner how its directly related to a common man. Note that this article is limited in its scope by looking at the two changes from the point of view of its direct impact on a common man.

Let me quickly go through two main changes which RBI recently changed and explain to you how it impacts common man. Note that this article is limited in its scope of looking at these two changes only from a viewpoint of how a common man is affected directly.

1. Increase in Repo Rate by 0.5% (6.75% to 7.25%) Repo rate is a rate at which Bank borrows money from RBI, which was increased by 0.5% by RBI and is at 7.25% right now. So now what are the effects of it on a common man? Lets understand this concept. Banks offer loans like Home loans and Auto loans to someone at an interest rate which is directly proportional to Repo rate (interest rate for common man = repo rate + X %). Now change in repo rate has a direct impact in the interest rates offered to customers for loans by the same or by more magnitude. Now with the increase of 0.5% in repo rate, this increase will directly be passed to a common man (in case of floating interest rates). In fact some banks like IDBI bank and Yes Bank have already increased their interest rate for loan takers. In fact, Chanda Kochar (Managing Director of ICICI Bank) has already said that this repo rate increase can increase the interest rates for end consumers in the range of 0.5% 1.0%. So if your interest rate for home loan or Auto loan was 10% p.a, it will now increase to 10.50% at least. This has direct impact on the EMI which you pay for your house. Lets see the calculations. If you had bought a house worth 30 lacs @10% interest, 15 yrs tenure, then the EMI would be Rs 32,238. With an increase of 0.5% in interest (10.5%), your EMI will rise to Rs 33,162. Thats an increase of Rs 924 on every EMI. However if the interest rates rise by 1%, in that case your EMI will increase by Rs. 1,860 (calculate yourself). Now imagine if you took the loan at the time of lowinterest rates and over the years the interest rates keep rising every quarter, your EMI can shoot up so much that it would make your cash flow very uncomfortable.

For example, just last year in Mar 2010, the repo rate was 5%, and then RBI increased it up to 7.25% today. This means there was a 2.25% increase in the last 14 months. You can understand the impact of this on EMI rise over the last 1 yr! Hence, now you understood how change in repo rate directly impacts a common man, because that change in repo rate is passed on to common man and his EMIs are affected in the case, the person has opted for floating interest rate option while taking the loan.

2. Increase of saving bank interest from 3.5% to 4% . The second change which RBI has done is to increase the saving bank interest rate. Till now it was 3.50% which was set long back, many years ago and was never revised. But finally with this years credit policy, RBI increases it to 4%. Now you must be thinking how does this impact common man? Its a good thing for account holders. Well, in a way its a good thing that a person will get higher interest rate on his cash lying in the saving bank account, but lets see how it impacts a bank. A bank that was paying 3.50% interest on the money will now have to pay 4% interest. That means now, it would directly impact Banks profitability. Suddenly a bank which was able to add up that 0.5% interest in its profits has to pay it to customers and that would hit their margins. Banks profits will come down by that much amount. This is not a good thing for the bank. Thats a simple reason why you should have expected a big fall in banking stocks and thats exactly what has happened on the day when this news came in that saving account interest has been raised. Banking and automobile stocks anchored the broad-based selling. While the hike in saving rates is expected to hit the net income margins of the banks; muted sales numbers in April, high fuel prices, and likely rise in auto loan, diminishing outlook for automobile space. Among banking stocks, Bank of India, PNB, SBI and Yes Bank tumbled 6.47 per cent, 5.07 per cent, 4.03 per cent and 4.03 per cent, respectively. ICICI Bank and HDFC Bank dropped 2.76 per cent and 2.40 per cent. (source) Note that around 22% of the money in banking system lies in normal savings bank account and thats approximately 10 lakhs crore in all the banks. Taking a hit of 0.5% on that kind of money is Rs 5,000 crore. Thats a direct impact of the bank margin of profits. The worst affected will be those banks where saving account ratio (the amount of money lying in bank accounts vs. total money with bank in all forms) is

very

high.

Clearly

banks

like ICICI bank, SBI bank,

Punjab

National

and HDFC banks are the names I can think because their saving bank deposits stand in range of 30-35%, much higher than the average of 20% across all other banks. Now how does this impact the common man? Again this move of increasing the interest rates for saving bank is going to affect banks profitability and banks are going to pass this burden to those people who take loans from them, which means those who only put money in bank will stand to gain and the people who took loan will be losing out.

Reserve Bank of India (RBI) announces reduction of cash reserve ratio (CRR) of scheduled banks by 75 basis points -9th March 2012 Reserve Bank of India has decided to reduce the cash reserve ratio (CRR) of scheduled banks by 75 basis points from 5.5 per cent to 4.75 per cent of their net demand and time liabilities (NDTL) effective the fortnight beginning March 10, 2012. This reduction will inject around Rs 480 billion of primary liquidity into the banking system.

In order to mitigate tight liquidity conditions, the cash reserve ratio was reduced by 50 basis points in the Third Quarter Review (TQR) of January 2012, injecting primary liquidity of Rs 315 billion into the banking system. The Reserve Bank also continued with the open market operations (OMOs), injecting primary liquidity of over Rs 1,245 billion this financial year so far, of which Rs 528 billion was injected after the TQR. Despite these measures, the liquidity deficit has remained large on account of both structural and frictional factors. This was reflected in the net average borrowing under the Reserve Bank's liquidity adjustment facility (LAF) rising from an average of Rs 1,292 billion in January 2012 to Rs 1,405 billion in February. Net injection of liquidity through LAF rose to a peak of Rs 1,917 billion on March 1, 2012, though subsequently it declined to Rs 1,273 billion on March 7, 2012.

Further, the liquidity deficit is expected to increase significantly during the second week of March due to advance tax outflows and the usual frontloading of cash balances by banks with the Reserve Bank. Thus, the overall deficit in the system persists above the comfort level of the Reserve Bank. Accordingly, it has been decided to inject permanent primary liquidity into the system by reducing the CRR so as to ensure smooth flow of credit to productive sectors of the economy.
As already announced, the Reserve Bank will provide its assessment of the macroeconomic situation in its Mid-Quarter Review to be published on March 15, 2012.

The Reserve Bank of India (RBI) has hiked its cash reserve ratio (CRR) by 75 bps to 5.75% as against 5% at its credit policy meet today. In an interview with CNBC-TV18, RK Bansal, ED & CFO, IDBI gave his reactions on the RBI's monetary policy and its impact on lending rates and credit growth. Q: What are your reactions to the entire hike and do you see the near term credit growth getting affected with the kind of liquidity that has been sucked out of the system? A: The CRR increase was expected. The market expected only a 50 bps but the RBI has come out with 75 bps. Keeping in view the liquidity in the system we don't envisage that it will affect the credit growth as such.

Q: What about loan rates because they inevitably would be hardening from here? A: Not really. If you look at a 75 bps CRR increase so that is only about 5bps increase in the lending rate. Really speaking maybe it could affect in an indirect way and because the liquidity would be reduced, so the lending which was happening at sub-BPLR rates, which are very low rates, there the interest rates could go up. But overall I don't envisage an increase in the BPLR itself.

Q: Do you see any kind of rate tightening on the back of this going in the next couple of weeks considering you are a part of the industry? What is the ground saying at this point in time post these rate hikes? A: I don't see that happening immediately. But overall keeping with the signal given by the RBI and as it has changed the inflation target to 8.5% now, so naturally for a very long time the deposit rates cannot be negative. Finally if you look at the deposit rates which are at about 6.5% and if the inflation becomes 8.5% virtually it's a negative deposit rate for the investor in that sense. So that would certainly affect in the long term if the inflation is not controlled within the next six months or so. Q: What about the liquidity situation because even when the liquidity was so high the credit growth was really not that sustainable and it didn't improve a whole lot. Right now post so much liquidity getting sucked out of the system what kind of credit growth are you envisaging going into the next say couple of quarters? A: This year the entire banking system was expecting a growth of about 18% earlier. But the RBI is maybe expecting slightly lower than that now. As far as IDBI Bank is concerned, we are still expecting a credit growth of about 20%. We are confident that we will be able to achieve that.