Towards a transparent home loan

The RBI has proposed that banks link interest rates to external benchmarks such as repo rate or T-Bill (Treasury Bill) Rate for 91 days. By Deshpande R. P.

A major grouse of home loan borrowers has been opacity in fixing interest rate on floating rate home loans, which constitute more than 90% of home loan portfolio.

Our country has seen four decades of formal housing finance lending. Thanks to the H.T. Parekh, who set up HDFC (Housing Development Finance Corporation) in 1977 against odds to establish a housing finance system in the country.

There was insignificant growth in the housing finance sector till the National Housing Bank (NHB) was established in 1988, under NHB Act, 1987. In the late 1980s, leading banks and insurance companies floated specialised housing finance subsidiaries and focussed on providing home loans. Until the dawn of the new millennium, home loans were sanctioned on fixed interest rates for the entire repayment tenure, normally extending up to 15 years. Once the loan was disbursed, EMIs (Equated Monthly Instalments) remained constant irrespective of interest rate movements in the economy.

It was in 2000 that ICICI Bank made a push for lending home loans and introduced floating rate/adjustable/variable rate at 2% less as compared to fixed rate loans offered by competitors. Thus the risk of absorbing interest rate movement, which was managed by the lenders until then, was passed on to borrowers. It was a wise move by ICICI, as it had envisaged that the portfolio of home loans in their books would increase enormously and floating rate loans will insulate the bank from interest rate movement risks. Rest is history.

All banks and housing finance companies followed suit and as a result, today more than 90% of home loans are under floating rate schemes.

No clear guidelines

Unfortunately, as there were no clear guidelines from regulatory authorities like RBI and NHB, banks and Housing Finance Companies (HFCs) started pegging interest rate to arbitrary benchmarks, which were devised internally with the main objective of benefiting the bank/HFC.

The borrowers were kept in the dark on how the benchmark rate was calculated, while the existing home loan borrowers were coerced to pay higher interest rates as compared to interest rates offered to new borrowers. When complaints started pouring in, the regulators instructed the lenders to be transparent in fixing the benchmark rate.

Benchmark change

The next 15 years saw banks and HFCs change the benchmark from PLR (Prime Lending Rate) to BPLR (Benchmark Prime Lending Rate), to Base Rate and to MCLR (Marginal Cost of Lending Rate), which is in practice now.

Although some transparency was visible after every change in benchmark rate, as it was calculated internally by the lending bank/HFC,a lot of ambiguity remained. Banks and HFCs retained the upper hand in fixing higher interest rates, especially on loan accounts of existing borrowers.

For transparency

In order to bring total transparency in charging interest rate on home loans, RBI has proposed that banks link the interest rates to external benchmarks such as repo rate, announced by RBI periodically, or T-Bill (Treasury Bill) Rate for 91 days.

The new guidelines are expected to be issued by RBI shortly and the new interest rate mechanism may come into effect from April 1, 2019.

Understanding the specifics

* Repo rate is the rate at which RBI lends money to commercial banks, as and when required by banks. It is announced periodically, considering a range of related parameters with an aim to control inflation. Repo rate genuinely captures the interest rates in the money market movements.

* Treasury Bills are short term (91 days, 182 days and 364 days) borrowing instruments of the Government of India which enable investors to park their short-term surplus funds. They are auctioned by RBI at regular intervals and issued at a discount to face value. Since interest on the treasury bills is determined by market forces, T-Bill rate could be a more realistic interest rate prevailing in a particular period.

Hence benchmarking either repo rate or T-Bill rate to fix interest rate on floating rate home loans could be a much better option. One can hope, as interest rates will have to be benchmarked to external rates, that banks may not be able to tweak interest rates to their favour any more.

Possibilities

Suppose a bank selects repo rate as benchmark rate. Looking at the present repo rate of 6.5%, the bank may charge 6.5% + margin of say 2.25%, totalling to 8.75%, as interest rate for standard home loans. Once RBI issues a detailed circular, things will be clearer, whether banks may charge any fee to shift from MCLR regime to Repo Rate/T-Bill Rate regime.

The National Housing Bank, which regulates HFCs, may follow suit in making it mandatory to benchmark home loan rates to external rates such as repo rate or T-Bill rate.

(The author, a mortgage banking expert, is MD, Abhrant Property Counselling Services, Bengaluru / [email protected])

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