RATE CONVERGENCE NO PLAN ON CURRENT LOANS

RBI may ask banks to bury pre-payment fine THE Reserve Bank of India (RBI) plans to direct banks to stop levying penalty on pre-payment of retail loans, heeding to a long-standing demand of borrowers availing of floating rate loans who find benefits of periodical interest rate cuts eluding them.      "The right to avail of loans at lower rates of interest should not be curtailed by prepayment penalties. We will direct banks to do away with the prepayment penalty in case of loans disbursed in future," said an RBI official. However, the banking regulator is yet to decide on whether this benefit should be given to existing borrowers, he said, requesting anonymity.      Currently, banks and institutions levy prepayment charges of 1-4% on refinancing of home, auto and personal loans. However, prepayment using own funds do not attract penalties in most case.      This move will lead to greater competition in the retail segment and result in the convergence in interest rates offered by various lenders, as borrowers will be able to refinance expensive loans with cheaper credit without attracting any penalty.      The banking regulator can ask banks to drop the prepayment penalty mentioned even in existing loan agreements, as the Indian Contracts Act provides that an appropriate authority can strike down a clause in a contract if it is against public policy.      If the penalty is dropped for existing loans as well, it could result in a rush of borrowers wanting to shift to public sectors banks, some of which are offering home loans at less than 8%.      Private sector banks charge anything between 2% and 4% of the outstanding loan amount as prepayment penalty, while public sector banks charge 1-1.5% for foreclosing a loan.      Shifting a housing loan of Rs 20 lakh, for instance, could invite a prepayment charge of up to Rs 80,000.      If the remaining tenure of the loan was 15 years and current interest rate 12%, shifting to a 10% loan would reduce the monthly installment by about Rs 2,500. The borrower would then need nearly 32 months to recover the pre-payment levy.      However, the mere possibility of the borrower shifting to another lender gives him the bargaining power to negotiate a lower rate on their floating rate loans. That lenders refuse to lower rates readily for existing customers in a falling rate regime has been a concern for borrowers and policymakers for a while.Prepayment complaints swell  WHEN state-run State Bank of India (SBI) started offering home loans at 8% interest rate to new borrowers in February, it received a spectacular consumer interest that helped it become the largest home loan provider in terms of both numbers of homes and volumes, toppling HDFC and ICICI Bank.      This forced the private sector lenders to cut rates on fresh loans to match the offers from public sector banks. But their existing customers did not receive the benefits of lower rates. This led to an exodus of their customers to state-run banks that aggressively bought out loans.      The central bank's move comes at a time when the Competition Commission of India (CCI) has also initiated an investigation into the practice of lending institutions levying prepayment penalties.      Officials with several public sector banks said such a directive will have a larger impact on private sector lenders. "We make a distinction between the prepayment of loans from own resources and taking over of loans by other lenders. If other lenders are taking over the loan then we charge close to 1% as a penalty. The directive will have minimal impact on us," said an official with SBI, the country's largest lender with close to 20% market share.      The customer grievance cell of RBI has received a large number of complaints against banks' prepayment charges. While replying to a query filed under Right to Information Act, the RBI did disapprove of the prepayment penalty charges last month. The central bank, however, did not give any directive to the banks at that time. Instead, it said that banks should lay out internal principles and procedures so that usurious charges are not levied on borrowers.      Prepayment charges on home loans from HDFC ranges between 0.5% and 3%, depending on the tenure of the loan, where the funding is coming from and what the interest rate on the loan is. ICICI Bank also charges a penalty of about 2% on prepayment of home loans, irrespective of whether it is obtained by refinancing or foreclosed by the borrower using own funds.