RBI allows switch from floating to fixed rate regime: What do new personal loan guidelines say?
Context- The Reserve Bank of India (RBI) has asked all regulated entities (REs), including banks and NBFCs, to give personal loan borrowers an option to switch over from a floating rate to a fixed rate regime at the time of resetting interest rates. In a circular on ‘Reset of floating interest rate on equated monthly installments (EMI) based personal loans’, the central bank said the borrowers will also be given the choice to opt for enhancement in EMI or elongation of the tenor.
(Credits- GeeksforGeeks)
What are the new changes?
- At the time of sanction, REs will have to clearly communicate to the borrowers about the possible impact of a change in benchmark interest rate on the loan leading to changes in EMI and/or tenor or both.
- Any increase in the EMI/ tenor or both will have to be communicated to the borrower immediately through appropriate channels.
- SWITCHOVER: At the time of reset of interest rates, REs will have to give the option to borrowers to switch over to a fixed rate as per their board-approved policy. The policy will also specify the number of times a borrower will be allowed to switch during the tenor of the loan.
- REs will have to disclose all applicable charges for switching loans from floating to fixed rate and any other service charges/ administrative costs in the sanction letter
- ELONGATION: The borrowers will also be given the choice to opt for enhancement in EMI or elongation of tenor or for a combination of both options, and to prepay, either in part or in full, at any point during the tenor of the loan, with foreclosure charges.
- REs should ensure that the elongation of tenor in case of a floating rate loan does not result in negative amortisation.
- The RBI said REs will have to ensure that these instructions are extended to the existing as well as new loans by December 31, 2023.
Why has RBI issued new regulations?
- The supervisory reviews undertaken by the RBI and the feedback and references from members of the public have revealed several instances of unreasonable elongation of tenor of floating rate loans by lenders without proper consent and communication to the borrowers.
- Banks can change the interest rate by changing the internal benchmark rate and the spread during the term of the loan which could harm the interest of the borrower and also impair monetary transmission.
- Borrowers have complained that banks normally change or reset the EMIs in an arbitrary manner and tenors are extended without informing the borrowers.
- Further, borrowers are not informed about the foreclosure charges. The RBI has also observed that unduly long elongation of tenor has camouflaged stress in banks.
What are personal loans?
- As per the RBI definition, personal loans are the loans given to individuals and consist of consumer credit, education loan, loans given for the creation or enhancement of immovable assets (such as housing loans), and loans given for investment in financial assets (shares and debentures). The total outstanding under the personal loan category was Rs 42.60 lakh crore as of June 2023
What’s the interest rate reset?
- When a customer takes a home loan, the interest rate reset clause in the loan agreement allows the lender to review the interest rate after a certain period, as per the occurrence of a scheduled reset date of the loan.
- EMI of a floating rate loan changes with periodical changes in reset interest rates. These rates and the calculation are not uniform for all the banks as the cost of funds differs from banks.
Conclusion- According to banks, when an external benchmark rate( banks use Repo rate now ) is adopted for fixing the lending rate, the reset period should be linked to the tenor of the underlying external benchmark. While longer reset periods increase transmission lags, shorter resets increase interest rate risk for banks.
Syllabus- GS-3; Monetary Policy
Source- Indian Express
