Resistance prompted by fears of liquidity mismatch; banks now want charges capped, not waived
Joel Rebello & Dinesh Unnikrishnan
Banks are lobbying hard against a move that was supposed to improve ties with customers—the abolition of penalties on the early repayment of floating rate home loans. Weeks after agreeing to waive the prepayment charges, banks now say they should be capped, but not waived.
The Indian Banks’ Association (IBA) lobby group has written to the Reserve Bank of India (RBI) arguing against the move, fearing mismatches in liquidity owing to early payment.
The IBA note, sent to RBI in the second week of September, was in response to recommendations made by a central bank-appointed committee on customer service in banks. Based on this, banks had adopted a charter of 10 action points early September to improve customer service, at the annual conference of banking ombudsmen in Mumbai.
The action point in question said: “Banks must not recover prepayment charges in floating rate loans.”
Banks charge 2-4% of the loan outstanding as prepayment charges from home loan customers. Money from this in turn allows banks to offer competitive home loan rates, analysts said. At least 95% of home loans bear a floating rate of interest, according to RBI.
“Any prepayment by a customer leads to maturity mismatches, which impacts banks’ liquidity,” a senior IBA official said. “When prepayment happens, there is a time gap before the bank can redeploy the funds. Therefore, we have said that prepayment penalty should stay in the industry, but at a reasonable level.”
He did not elaborate on what this “reasonable level” could be.
The IBA official declined to be identified because the note is not in the public domain and is a private communication between RBI and the grouping.
The asset-liability mismatches stem from the average maturity of bank deposits being around three years and most home loans having a term of 15-20 years.
The central bank had pointed out the risks that could accrue from prepayment charges in a note on the 10-point action plan.
“Floating rate loans pass on the interest rate risk from banks which are much better placed to manage it to borrowers and, thus, banks only substitute interest rate risk with potential credit risk,” RBI said in the September note.
RBI last year formed an eight-member committee, headed by former Securities and Exchange Board of India chairman M. Damodaran, to look into banking services and the redressal system for retail and small customers, and suggest measures for expeditious resolution of complaints.
The committee had mentioned that “foreclosure charges are seen as a restrictive practice deterring the borrowers from switching over to cheaper available sources...especially when some banks are offering lower interest rate benefits to new customers, also the floating rate is anchored to an internal rate”.
“Regulation should plug such anomalies which create doubts about fairness regarding pricing, which should be transparent, non-discriminatory and also objective,” the committee had said.
Bankers say the action plan is not binding.
“IBA and bankers were present for a brief period in the conference and the decisions there were just discussions and not instructions,” said IBA chief and Bank of Baroda chairman and managing director M.D. Mallya. “We have to still examine them.”
The banks were represented at the meeting by Mallya, State Bank of India (SBI) chairman Pratip Chaudhuri and IBA chief executive officer K. Ramakrishnan.
At the end of the conference, RBI had issued a note, saying “these decisions were taken at the annual conference”, referring to the 10 action points.
An RBI spokesperson said a notification to implement the decisions taken at the conference will come “sooner or later”.
“We will have discussions with IBA,” the spokesperson said.
IBA’s Ramakrishnan said the suggestions at the ombudsmen’s meeting will have to be referred to a standing committee at the banker’s body.
An official with a private mortgage firm said besides asset-liability mismatches, banks are also worried about losing customers to rivals offering cheaper loans if they stop charging prepayment fees, as this will no longer be a deterrent for switching.
“Banks price loans according to their liabilities. They cannot shift the goal posts as and when rates change,” he said. “Housing finance companies currently offer prepayment without any fees only if the customer is not
shifting and foreclosing loan through his own money.”
IBA also points to the Competition Commission of India (CCI) having first challenged and then allowed
prepayment fees. CCI’s decision was, however, based on the premise that the fee was valid because it was part of an agreement between the bank and customers, said Uday Wavikar, vice-president of the Consumer Court Bar Association for Maharashtra and Goa.
“But now, when the regulator has directed a change, it becomes an unfair trade practice and banks can be challenged,” he said.
Outstanding home loans in India’s financial system amount to Rs5.5 trillion. Housing Development Finance Corp. Ltd and SBI are the biggest lenders.
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