Pre- payment penalty on floating Rate Home Loans May Come Back..

Mr. Harsh Roongta, Apnapaisa.com

The Reserve Bank of India (RBI) recently extended the ban on charging of prepayment charges from home loans to all floating rate loans given to individuals. However, this position could be reversed if the recommendations of the working group set up "to examine the issues related to discrimination in pricing of credit and recommend measures for transparent and appropriate pricing of credit under a floating rate regime" are accepted.

Unfortunately, their recommendations, if implemented, are unlikely to result in a fairer regime. In fact the recommendation, if accepted, might lead to a more unfair regime.

 

Harsh Roongta, Apnapaisa.com

 Given the group's mandate, it is surprising that the very first recommendation is a rather curious definition of 'discrimination' (two similar borrowers getting different rates from the same bank when borrowing at the same time) and distinguishing it from what they term as 'differentiation' (or old borrowers paying more than similar new borrowers).

This is surprising, since they have taken a tough stance on 'discrimination' as defined by them, even though it is a non-issue, while 'differentiation' (the raison d'être for the group) has been described by it as inevitable.

The group's recommendation virtually justifies 'differentiation' by accepting the same arguments that the banks have provided so far. The average cost of funds drops slowly as interest rates drop because bank depositors finish the term of their deposits at the higher rate and only fresh deposits are at a lower rate and, hence, the benefit can be passed on only slowly.

On the other hand, it argues when interest rates rise, depositors have an option to prematurely close their deposits and redeposit back at a higher rate. Thus, when interest rates rise, the bank's average cost of funds rise quickly and need to be passed on quicker to all consumers.

While this sounds logical, no evidence is adduced to counter the widely held belief that few Indian fixed deposit holders break their deposits to take advantage of higher rates. If not too many fixed deposit (FD) holders are breaking their fixed deposits to take advantage of higher rates then clearly the 'base rate' at best should move upwards just a tad faster than it moves downwards.

In fact, doubts about the fairness about this downward stickiness will reduce if the calculations of base rate are made transparently available to the public through the banks website. The base rate is allowed "…. to use any methodology as considered appropriate, provided it is consistent.."

Public scrutiny will ensure that the banks are indeed following a consistent methodology while calculating their base rates and reduce the widespread public dissatisfaction that is currently prevalent on this issue. I am willing to place a reasonable wager that if base rate calculations are made transparent we will find them almost as sticky on the upward side as they are on the downward side today.

Another recommendation bats for re-introducing the exit penalty as on option for a cheaper floating rate loan. Again, this recommendations sounds good on paper (cheaper rate if you accept prepayment penalty and higher rate if you want nil prepayment penalty) but given the manner in which consumer facing regulations are practised in India, it is most likely to be mis-used and mis-sold.

When the benchmark rate cannot be fixed transparently, the least that the consumer can be given is a costless (and painless) exit ability. The central bank must stick to its current stand disallowing any prepayment charges on floating rate loans to individuals.

The next recommendation is about IBA "evolving a set of guidelines for easier & quicker transfer of loans particularly mortgage / housing loans".

This provides for a mechanism in which the old lender can share know-your-customer (KYC) documents of the borrower with the new lender. That is a meaningless recommendation since the borrower can easily provide the KYC documents.

What the mechanism needs to do is provide for an IBA-approved mechanism for transfer of security documents directly from the old to the new lender, making the transfer process 'painless' for the consumer. This is the biggest issue faced by consumers and the new lender while transferring loans from one lender to another. Making the transfer process painless (it is already costless) will go a long way in ensuring the interest rates charged are fair, even if the regulations themselves do not provide a transparent basis for calculating the benchmark rate.

There are quite a few extremely useful recommendations on non increase of spreads, fixed reset dates, sunset clause on existing BPLR loans, standardisations, uniform disclosure of rates and charges, etc, which should be implemented as quickly as possible.

But, real transparency will be possible only if fixation of base rates is made more transparent and exit is made "painless" and remains 'costless'.

About the author..

The writer is Mr. Harsh Roongta, CEO, Apnapaisa.com

http://in.linkedin.com/in/harshroongta

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