In a bid to improve transparency, Reserve Bank of India recently issued a circular on the processes lenders must follow when they offer retail loans with floating interest rates. The rules require banks and non-banking finance companies to be upfront about how rate increases will affect EMIs (equated monthly instalments) and tenors. Lenders are also expected to give borrowers a choice between higher EMIs and longer tenor, or a switch to fixed rate loans, when rates get reset. All this is welcome, because very few banks and NBFCs currently seem to follow the above practices, which should have been standard features of the lending contract.

The trigger for these guidelines seems to be the steep increase in borrower obligations, particularly on home loans, set off by the 250-basis point hike in policy rates in the past year. As floating rates got reset, many lenders extended loan tenures suo moto, to prevent borrowers from feeling the pinch of higher EMIs. This resulted in loan tenures stretching far beyond the borrowers’ active income generating years, in some cases. In others, this gave rise to negative amortisation, where the EMI paid no longer covered even the borrowers’ interest dues, adding to their loan burden. The RBI’s new rules try to give the borrower more discretion on how she manages her higher obligation. Now lenders will need to offer the option of a higher EMI, a longer tenure, conversion from a floating to fixed rate loan, a switch to another lender or pre-closure.

While the move may make borrowers more aware of these options, current lending practices of banks and NBFCs do not make it easy for the borrower to choose. Take the switch from floating to fixed rate loans, for instance. Presently, fixed rate home loans are offered at 14-17 per cent and auto loans at 16-18 per cent, while floating rate loans (after the increases) are at 9-10.5 per cent for homes and 10-12 per cent for cars. The yawning differential between fixed and floating loans is a deliberate deterrent to any borrower opting for the former. The option to switch to a rival lender for a better rate is also not straightforward. It involves prolonged negotiations and comes with high processing charges. Banks also make it difficult for their retail borrowers to pre-close loans. While on paper lenders should not impose pre-closure charges, such charges are invariably recovered from the borrower. While most lenders pride themselves on a seamless, end-to-end digital process for loan application and processing, the procedure for pre-closure remains laborious. Nor is the process subject to any specific timeline.

On top of all this, most retail borrowers are not even aware of the loan terms and conditions they’ve signed up for, as lenders often don’t share a copy of the loan agreement with them unless specifically demanded. Therefore, while more disclosures are a good first step, there’s a lot of ground to cover before retail loans can be deemed borrower-friendly.  

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