On interest rates and home loans
Fellow blogger Amit Shekhar has requested for a detailed analysis of the recent repo rate hike by RBI and its impact, particularly on home loan rates. Amit authors two great blogs Indian Thinking and Bombay Today. He writes on contemporary issues and trends in areas as diverse as technology, business and crime. His writings are deep and thought-provoking. “ …. blogging is my way of connecting to the world, cause i believe there are like minded and fresh thinkers around to praise advise and encourage.”, Amit says.
Here's my take on the repo rate hike announced by RBI in its quarterly policy review on 31st January. I have tried to analyse the significance of repo rate as the signal rate for the economy, reasons for the monetary tightening in the context of current and evolving economic situation, future course of interest rates and housing loans market. I believe housing loans will gradually lose their status as the most preferred segment for the bankers and will become costlier for the consumers as interest rates in the economy rise further and policy preferences change.
As Indian economy and the interest rate cycle are at a very interesting stage, I will be writing more on the subject in the coming weeks. Please give your opinion and feedback.
What is the significance of repo rate?
RBI conducts daily repo auctions as part of its liquidity adjustment facility (LAF). Repo is the short form of repurchase which refers to lending or borrowing against marketable securities (such as government bonds). This is used by RBI as a tool to manage the system liquidity – banks having surplus intraday cash can lend to RBI (at reverse repo rate – currently 6%) and those having shortfall can borrow from RBI (at repo rate – currently 7.50%). Although these are short term (overnight) rates, repo and reverse repo rates are used as the signal rates for the economy.
Why has RBI been raising interest rates?
As Indian economy has been growing strongly, the central bank’s primary concern is to avoid over-heating and a likely surge in inflation (inflation is already beyond the informal tolerance range of 5-5.50%). Typically, periods of high growth culminate into formation of asset price bubbles in pockets of the economy, like stock markets, real estate, etc. By raising interest rates in a measured way, RBI has been trying to cool down inflationary pressures and to avoid the undesirable side effects of high growth like escalating asset prices.
What is the significance of the latest rate hike?
The latest repo rate hike is one step in a series of measures that RBI has been taking in the past couple of years to address the concerns arising from high growth. To be precise, since September, 2004 repo rate has been increased by 125 bps, reverse repo rate by 150 basis points and the CRR by 100 basis points. CRR – cash reserve ratio - is the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank. A higher CRR will mean banks have lesser money available for lending, hence will charge higher interest rates.
Simultaneously, RBI has also taken measures to avoid building up of asset price bubbles, especially in the real estate sector and has been trying to reduce the flow of funds from banking system into the hot property market (as also other potential ‘trouble-spots’). Towards this end, it has taken steps like increasing the risk weights for housing loans from 50 per cent to 75 per cent, for commercial real estate from 100 per cent to 150 per cent and consumer credit from 100 per cent to 125 per cent, increasing provisioning requirement for standard advances for personal loans, credit card receivables, loans to real estate and capital markets. All this means the borrower will have to pay a higher interest rate for such loans.
More rate hikes to come?
There are clear indications that the rate tightening cycle – “measured increase in interest rates” - will continue. Domestic economy is expected to continue on the high growth trajectory and containing inflation will be high on the monetary policy agenda. Who wants a double-digit growth and double digit inflation? Global trends also point to a continued high interest rate bias. Global growth continues to be strong despite fears of a slowdown in US. Although there are no signs of a runaway inflation growth in the major economies, the central banks do not want to let their guard down.
Will home loan rates rise?
Yes. With loan growth out-stripping deposit growth and liquidity drying up, banks are feeling continued pressure on their borrowing costs. This is evident in the scramble to mobilize deposits and the rise in deposit rates by many leading banks in the recent past. Although there may not be immediate increases because of the latest repo rate increase (this was widely expected), there will definitely be upward pressure on home loan rates because of the overall rise in interest rates in the economy.
Some respite for the banks may come in the Budget if the lock-in period for tax rebate on long term deposits is reduced from 5 years to 3 years – banks would be able to mobilize more deposits. But, another factor that will play against home loan borrowers is a growing feeling among policy-makers, especially in RBI, that there is a good deal of speculative money flowing into the property market (including residential property) through banks. Although the current focus is on reducing the flow of funds into commercial real estate, RBI has made it clear that it is not happy about the bankers going all out to woo the housing loans borrowers. RBI has urged upon banks to re-jig their credit portfolio – from the hot housing loans and personal loans into 'more productive sectors' of the economy. The Governor's worry about the under-performance of agriculture expressed in policy statements is a clear sign of where the central bank wants the bankers to lend. Even the government is likely to give a big push to agriculture sector in this year's budget (and beyond) and banks will be called upon to play a bigger role in this.
I believe, housing loans will gradually lose their status as the most attractive sector for the bankers and become costlier for the consumer, as interest rates in the economy rise further and policy preferences change. Same for personal loans and credit cards.
An update
Indian Bank has announced that it is increasing its benchmark prime lending rate (PLR) by 50 basis points to 12.5 per cent, deposits rates by 25-50 basis points and home loan rates by 25 basis points across all tenors from February 1.
Fellow blogger Amit Shekhar has requested for a detailed analysis of the recent repo rate hike by RBI and its impact, particularly on home loan rates. Amit authors two great blogs Indian Thinking and Bombay Today. He writes on contemporary issues and trends in areas as diverse as technology, business and crime. His writings are deep and thought-provoking. “ …. blogging is my way of connecting to the world, cause i believe there are like minded and fresh thinkers around to praise advise and encourage.”, Amit says.
Here's my take on the repo rate hike announced by RBI in its quarterly policy review on 31st January. I have tried to analyse the significance of repo rate as the signal rate for the economy, reasons for the monetary tightening in the context of current and evolving economic situation, future course of interest rates and housing loans market. I believe housing loans will gradually lose their status as the most preferred segment for the bankers and will become costlier for the consumers as interest rates in the economy rise further and policy preferences change.
As Indian economy and the interest rate cycle are at a very interesting stage, I will be writing more on the subject in the coming weeks. Please give your opinion and feedback.
What is the significance of repo rate?
RBI conducts daily repo auctions as part of its liquidity adjustment facility (LAF). Repo is the short form of repurchase which refers to lending or borrowing against marketable securities (such as government bonds). This is used by RBI as a tool to manage the system liquidity – banks having surplus intraday cash can lend to RBI (at reverse repo rate – currently 6%) and those having shortfall can borrow from RBI (at repo rate – currently 7.50%). Although these are short term (overnight) rates, repo and reverse repo rates are used as the signal rates for the economy.
Why has RBI been raising interest rates?
As Indian economy has been growing strongly, the central bank’s primary concern is to avoid over-heating and a likely surge in inflation (inflation is already beyond the informal tolerance range of 5-5.50%). Typically, periods of high growth culminate into formation of asset price bubbles in pockets of the economy, like stock markets, real estate, etc. By raising interest rates in a measured way, RBI has been trying to cool down inflationary pressures and to avoid the undesirable side effects of high growth like escalating asset prices.
What is the significance of the latest rate hike?
The latest repo rate hike is one step in a series of measures that RBI has been taking in the past couple of years to address the concerns arising from high growth. To be precise, since September, 2004 repo rate has been increased by 125 bps, reverse repo rate by 150 basis points and the CRR by 100 basis points. CRR – cash reserve ratio - is the amount of cash (as a percentage of bank deposits) that banks are required to set aside and maintain with the central bank. A higher CRR will mean banks have lesser money available for lending, hence will charge higher interest rates.
Simultaneously, RBI has also taken measures to avoid building up of asset price bubbles, especially in the real estate sector and has been trying to reduce the flow of funds from banking system into the hot property market (as also other potential ‘trouble-spots’). Towards this end, it has taken steps like increasing the risk weights for housing loans from 50 per cent to 75 per cent, for commercial real estate from 100 per cent to 150 per cent and consumer credit from 100 per cent to 125 per cent, increasing provisioning requirement for standard advances for personal loans, credit card receivables, loans to real estate and capital markets. All this means the borrower will have to pay a higher interest rate for such loans.
More rate hikes to come?
There are clear indications that the rate tightening cycle – “measured increase in interest rates” - will continue. Domestic economy is expected to continue on the high growth trajectory and containing inflation will be high on the monetary policy agenda. Who wants a double-digit growth and double digit inflation? Global trends also point to a continued high interest rate bias. Global growth continues to be strong despite fears of a slowdown in US. Although there are no signs of a runaway inflation growth in the major economies, the central banks do not want to let their guard down.
Will home loan rates rise?
Yes. With loan growth out-stripping deposit growth and liquidity drying up, banks are feeling continued pressure on their borrowing costs. This is evident in the scramble to mobilize deposits and the rise in deposit rates by many leading banks in the recent past. Although there may not be immediate increases because of the latest repo rate increase (this was widely expected), there will definitely be upward pressure on home loan rates because of the overall rise in interest rates in the economy.
Some respite for the banks may come in the Budget if the lock-in period for tax rebate on long term deposits is reduced from 5 years to 3 years – banks would be able to mobilize more deposits. But, another factor that will play against home loan borrowers is a growing feeling among policy-makers, especially in RBI, that there is a good deal of speculative money flowing into the property market (including residential property) through banks. Although the current focus is on reducing the flow of funds into commercial real estate, RBI has made it clear that it is not happy about the bankers going all out to woo the housing loans borrowers. RBI has urged upon banks to re-jig their credit portfolio – from the hot housing loans and personal loans into 'more productive sectors' of the economy. The Governor's worry about the under-performance of agriculture expressed in policy statements is a clear sign of where the central bank wants the bankers to lend. Even the government is likely to give a big push to agriculture sector in this year's budget (and beyond) and banks will be called upon to play a bigger role in this.
I believe, housing loans will gradually lose their status as the most attractive sector for the bankers and become costlier for the consumer, as interest rates in the economy rise further and policy preferences change. Same for personal loans and credit cards.
An update
Indian Bank has announced that it is increasing its benchmark prime lending rate (PLR) by 50 basis points to 12.5 per cent, deposits rates by 25-50 basis points and home loan rates by 25 basis points across all tenors from February 1.
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