In a move to protect borrowers from interest rate fluctuations and reduce the burden of equated monthly installments, a Reserve Bank of India committee has suggested banks to offer loan products which can have a repayment period of 30 years, in addition to the existing products. Banks have been suggested that such loan products may have interest reset provision, every 7-10 years, but lenders should be mindful of customer’s interest and should not violate regulatory guidelines on base rate.
“The Indian financial system has G-Secs upto 30 years, a benchmark to issue and price 30 year bonds by banks. Banks could, therefore, make efforts to offer longer-tenor fixed rate loans, say upto 30 years which would help reduce the EMIs of the borrowers,” the KK Vohra panel which was appointed to the study the feasibility of introducing more long-term fixed interest rate loan products said in its final report today.
The panel is of the view that banks could have the option to fix a reasonable cap and floor (200 or 300 bps) at the time of reset in relation to the interest rate originally charged to the borrower. The suggestion is made to protect both customers and banks from the risks arising out of adverse movements in interest rates.
Banks have also been advised to introduce hybrid loan products having both fixed and floating interest rate loans with a higher proportion of fixed rate loan, for example, for two-third for the repayment schedule.
Fixed rate loan products which were popular before 2,000 lost its sheen once interest rates started to fall which made banks focus on floating rate products. The RBI panel has observed that most home loan products which are generally on 15-25 years maturity period, are floating in nature. Auto loans, which are of 5-7 years tenure, are mostly offer fixed rates.
Since bank deposits are mostly below 5 years, emphasising on longer term fixed rate loan products may create asset liability mismatch for banks. In order to tackle the issue, the panel suggested that banks should issue more long term bonds, with a minimum maturity of 5 years, to the extent of their exposure to the infrastructure sector (minimum residual maturity of 5 years).
“Banks should popularize the fixed deposit schemes with tenors of above 5 years as the same are eligible for tax exemption. This would to some extent meet the long-term funding requirement of banks,” the panel said.
Though RBI has banned pre-payment penalty on floating rate loans, but the panel has suggested banks could be allowed to charge pre-payment penalty on fixed rate loan products on the outstanding amount only. However, the panel also said, that penalty should be reasonable so that it does not act as a disincentive for the fixed rate loan borrowers.