How a rate change reaches your loan

The MPC votes. The repo rate changes. Nothing has yet happened to anybody's loan.

Transmission is the process connecting the two, and it is slower, weaker and more asymmetric than the headlines imply.

The chain

1. The MPC changes the repo rate
2. Overnight money market rates move, within the corridor of chapter 6
3. Banks' own funding costs move — but only as existing funding matures and is replaced
4. Banks change their lending rates
5. Borrowers' EMIs change, at the next reset date
6. Spending and investment respond
7. Inflation responds, over several quarters

Every step has a lag, and steps 3 and 4 historically had the largest and most variable ones.

The asymmetry that forced a rule change

The persistent complaint, and it was well evidenced: lending rates fell slowly when the repo fell, and rose quickly when it rose.

The mechanism was not conspiracy. Under the older regimes a bank's lending rate was linked to its own cost of funds, which the bank computed. A cut in the repo lowers the cost of new funding, but a bank's deposit book is mostly older deposits at older rates, which reprice only as they mature. So the bank's average cost falls slowly — and a lending rate honestly derived from it falls slowly too.

The trouble was that the calculation gave the bank latitude, and latitude plus a margin incentive produces a predictable direction.

The external benchmark fix

The RBI's directions on interest rates on advances require certain categories of floating-rate loans to be linked to an external benchmark — a rate the bank does not compute, such as the repo rate or a Treasury bill yield.

The change is structural rather than exhortatory. A benchmark the bank does not calculate cannot be managed by the bank, so a repo cut reaches the benchmark immediately and automatically.

The earlier marginal cost of funds based lending rate (MCLR) regime still governs older loans and some categories, which is why two borrowers at the same bank can experience the same policy decision very differently depending on which regime their loan sits in.

What your EMI actually depends on

Working the problem. Your rate is:

$\text{Lending rate} = \text{External benchmark} + \text{Spread} + \text{Credit risk premium}$

The benchmark moves with the repo. The bank does not control it. This is the part that now transmits.

The spread is the bank's margin over the benchmark. The bank sets it, and while it cannot normally be changed arbitrarily during the loan's life, it is set at origination — so a bank can offset a policy cut on new loans by widening the spread.

The credit risk premium reflects you specifically. The bank sets it, and it can be revised if your credit standing changes — which means it can move against the benchmark, rising while the repo falls.

Then two more things decide what you actually pay:

The reset frequency. A floating rate linked to an external benchmark resets periodically, not continuously. A cut today may not reach you for months.

Whether the EMI or the tenure changes. Most Indian floating-rate home loans hold the EMI constant and adjust the tenure. So a rate cut often shortens your loan rather than reducing your monthly payment — real benefit, invisible in the EMI.

Of the five, the bank controls two and a half. That is why the external benchmark improved transmission substantially without completing it.

The deposit side, which is slower still

Lending rates are regulated into transmitting. Deposit rates are not benchmark-linked.

The consequence is predictable and worth knowing as a saver: when the repo falls, your loan rate falls fairly promptly and your deposit rate falls when the bank chooses. When the repo rises, your loan rate rises promptly and your deposit rate rises when competition forces it.

A bank's net interest margin therefore tends to widen in a rising-rate cycle and compress in a falling one, which is visible in bank results and is not an accident of execution.

Why transmission is weaker than the theory

• Small savings schemes offer administered rates that do not move with the repo, so banks cutting deposit rates lose funds to them. That sets a floor on how far deposit rates can fall.
• A large share of lending is fixed-rate or MCLR-linked, which transmits slowly or not at all.
• Credit demand matters more than price in a downturn. Cheaper money does not create borrowers worth lending to — chapter 2's binding constraint.
• NBFCs fund themselves differently — chapter 11.

The point

A repo change reaches a borrower through funding costs, lending rates and reset dates, and the chain is slow and asymmetric because a bank's existing deposits reprice only as they mature. Linking floating-rate loans to an external benchmark the bank does not compute fixed the largest gap, but the spread, the credit premium, the reset date and the EMI-versus-tenure choice remain — and deposit rates were never benchmarked at all.