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RBI Recommendations To Help Home Loan Borrowers Soon!
The RBI, on 10th April 2014, placed the Draft Report on Working Group on Pricing of Credit for public comments. The report is a welcome step in the direction of bringing transparency in credit pricing and better transmission of policy rates, particularly in a falling interest rate scenario. 

Myloan.in believes that with general expectations of slight softening of interest rates in the medium term, the recommendations of the report, if implemented, will greatly benefit home loan borrowers.
The main recommendations that myloan.in believes will benefit the home loan and car loan retail borrowers are:

1). Transparency in setting the benchmark rate or base rate, suggestion for IBA set base rate – banks set their own base rate subject to the condition that they cannot lend to any customer below the base rate. Tracking the movement of individual banks’ base rates since July 2010, myloan.in observes that:

During this period, the RBI has raised its benchmark repo rate by 250 bps , Among large public sector banks, SBI’s base rate has increased by the same 250 bps, those of PNB and IDBI Bank have increased by 225 bps each and those of OBC and IOB have increased by 200 bps each,Among private sector banks, the ICICI Bank’s base rate has increased by 250 bps (same as repo rate). However, when we look at smaller private sector banks, base rate of IndusInd bank has risen by 400 bps, that of Yes Bank by 375 bps, and those of Axis Bank and Kotak Bank by 275 bps each, Among foreign banks, Standard Chartered Bank and Citibank have raised their respective base rates by 250 bps, while Deutsche Bank and HSBC have raised their respective base rates by 320 bps and 275 bps

It is difficult to understand how, for banks operating in the same macro environment, the base rate movements can be so different ranging from 200 bps to 400 bps over the same period of time. In this light, RBI’s suggestions of linking base rates to marginal cost of funds and about an IBA determined base rate (IBRR) are welcome moves from a home loan borrower’s standpoint.

2). Keeping the spread over base rate constant for floating rate loans. Interest on a floating rate loan is calculated as combination of two factors – a benchmark (or base rate) and a spread above it.

Conventional wisdom and common sense suggest that while the applicable interest rate varies with the market movement, the spread remains constant. That’s why the floating rate loans have a “benchmark”. Some banks have taken a view that in a floating rate loan, not only can they vary the benchmark, but also the spread. To consider an illustration, assume a bank sanctions a home loan at 10.25% with the benchmark at the time of sanction being 9.75% and the spread being 0.50%. Let’s consider a scenario of rising interest rates whereby in the next reset cycle, the bank’s benchmark rate has gone up to 10.00%. Logically, the interest rate on the loan should move up to 10.00% plus 0.50%, that is 10.50%. However, what if the bank decides to also increase the spread from 0.50% to say, 1.00% and take the interest rate on home loan to 11.00%?

Now, let’s consider the opposite scenario, one of falling interest rates whereby the bank’s benchmark drops to 9.50%. Here again, instead of reducing the applicable rate on customer’s home loan to 10.00%, what if the bank decides to increase the spread from 0.5% to say, 0.75% and keep the interest rate on home loan unchanged at 10.25%?

Howsoever illogical this may sound to ordinary borrowers, some banks have regularly practiced this, leading to plethora of complaints with nodal officers and even the RBI Banking Ombudsman.

The RBI working group has now suggested that the spread must remain constant except in case of a change in credit quality of the customer. This proposed move is one that home loan borrowers must welcome and thank the RBI for.

3). Easing process of home loan balance transfer

With the abolition of penalty or charges on foreclosure even by way of home loan balance transfer in case of floating rate loans, more and more home loan borrowers are opting for home loan takeover to take advantage of lower rates offered by banks to new borrowers.

Some procedural issues need to be resolved to make the process easier. These relate to:

Transfer of property documents, which tends to hold up the loan transfers. Procedural hurdles some banks impose in loan transfers. Some banks insist on a minimum notice period, of say, 15 days, to process a balance transfer request. Further, they tend to drag their feet on providing requisite documents like list of documents and foreclosure letter. Some banks hold up the request citing ‘internal process ad approval” – though the fact is that the customer is only exercising his right and hence needs no approval.

Creation of a central third party and independent depository of property documents will go a long way in ensuring smoother and quicker transfer of home loans. Further, a mandatory directive to process home loan balance transfer across the counter is called for.

Now, it would be great if the RBI Working Group recommendations are also made applicable to the home finance companies that are governed by the National Housing Bank (NHB). It is noteworthy that the NHB had taken the lead on abolishing prepayment penalty on floating rate home loans. So, who knows, if the NHB may soon also bring in similar regulations soon.

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