Floating Home Loan Rates – A royal ride by banks on customers!!

The floating rate mechanism for Home Loans is one of the most abused tools in the hands of Banks in India.
Floating rate home loans
Floating rate home loans are those where the interest rate is tied up to a base rate plus a floating element thereof. So, if the base rate varies the floating interest rate also varies. A floating rate package should be pegged to an external rate but almost all the banks in India peg it to their own benchmark PLR. A floating interest rate normally has a low teaser rate to entice customers but how it actually performs in the later period in Indian conditions is unknown to customers on account of total lack of transparency.
In a typical floating rate loan, the interest rate can move up or down in line with the market conditions. If the interest rate changes, one can either keep one’s repayments at the same level and change the term of the loan, or keep the term of the loan the same and change one’s repayments.
If the interest rate goes down, the loan will get paid off earlier by keeping EMIs at the same level or reduce the EMIs and repay the loan over the same term.
If the interest rate goes up, one can take a longer term to pay off the loan by keeping the EMIs at the same level or increase the EMIs if one wants to repay the loan over the same term.
In spite of the clear directions given to the banks by RBI to adopt external benchmarks to determine their floating rates in a transparent manner, it has been a disappointing experience for customers that the Banks continue to flout the regulatory directions to the disadvantage of customers.
The justification given by the banks for their action is that RBI has increased the Reserve Ratios and Repo rates and consequently the cost of funds have gone up for Banks. The reserve ratios are the CRR and SLR. The Bank rate may also be relevant in some cases.

What is CRR?
CRR (Cash reserve Ratio) is the amount of funds that the banks have to keep in liquid cash in an account with RBI. If RBI decides to increase the percentage of CRR, the available amount with the banks to lend comes down. RBI is using this method (increase of CRR rate), to drain out the excessive money from the banks in times of inflation with a view to reduce public spending. The CRR which was 5.25% in 2006 went up to 9 % in August 2008 and is presently at presently at 5.50%.

What is SLR?

SLR (Statutory Liquidity Ratio) is the amount a Bank needs to maintain in the form of cash, or gold or govt. approved securities (Bonds) before providing credit to its customers. SLR rate is determined and maintained by the RBI in order to control the expansion of bank credit. SLR is determined as the percentage of total demand and time liabilities (i.e the total Current, Savings and Term deposits with Banks). The SLR was 25% and not revised after 25/10/1997. It was reduced to 24% w.e.f. 07/11/2008.

What is Repo Rate?

Whenever the banks have any shortage of funds they can borrow from RBI. Repo rate is the rate at which banks borrow funds from RBI. When the repo rate increases borrowing from RBI becomes more expensive for Banks. Conversely a reduction in the repo rate will help banks to get money at a cheap rate. The Repo rate which was 6.25% in 2006 went up to 9% in July 2008 and is presently at 5.50%

What is Bank rate?

Bank rate is the rate of interest which RBI charges on the loans and advances that it extends to Banks. Changes in the bank rate are used by RBI to control the money supply. The RBI has not revised the Bank Rate after 29/04/2003 and it continues to be at 6%.

The RBI has very clearly directed the Banks periodically through its circulars/master circulars (dated 01/07/08, 02/07/07 & 01/07/06) that in respect of their floating rate lending mechanism they should ensure the following:
Ensure transparency
Use only external or market-based rupee benchmark interest rates for pricing of their floating rate loan products
The methodology of computing the floating rates should be objective, transparent and mutually acceptable to counter parties
Banks should not offer floating rate loans linked to their own internal benchmarks or any other derived rate based on the underlying
This methodology should be adopted for all new loans
In the case of existing loans of longer / fixed tenure, banks should reset the floating rates according to the above method at the time of review or renewal of loan accounts, after obtaining the consent of the concerned borrower/s.
Even during 2004 and 2005 also RBI has directed the Banks to follow the external benchmark rates in a transparent manner for pricing their floating rate loans.

The Banks on their part have apparently ignored all these directions:
There is no transparency on the part of Banks in so far as they do not publish as to how they arrive at the floating rates or the revisions
The Banks do not use external or market-based rupee benchmark interest rates for pricing of their floating rate loan products but use their own PLR (Prime Lending Rate)
The methodology of computing the floating rates is not objective or transparent and there is no consultation with the customer, leave alone make the floating rate acceptable to him/her
The RBI prescribed methodology is not adopted for any loan – new or old
In the case of existing floating rate loans of longer / fixed tenure with banks, no review or renewal is carried out and the consent of the concerned borrower/s has not been sought for increasing the interest rate.
Many banks do not even send notice to the customer on the interest rate revision

When the CRR and Repo rates were increased by RBI, the banks were very quick in increasing the interest rates on floating rate loans across the board. Now the cost of funds as can be seen from the present CRR and Repo rates is the same or even lower than the levels existed during 2005 -06 as the RBI has substantially decreased the CRR and Repo rates. Even then Banks are very reluctant to reduce the rates of interest on the floating rate loans. Even if they reduce the interest rates, will the rates ever go to the levels as existed in 2005 and 2006 even after the RBI has obliged the Banks with very low cost for their borrowing?
Unfortunately there is no established term money market in India to which the floating rate could have been linked. As long as Banks use their own PLR as base rate to peg the floating interest rates, there will be no salvation to Customers. Instead, Banks should be advised by RBI to start linking their floating rates to an external rate like Repo rate or the 10 year bond rate so as to protect the interest of Customers and the reset period to be uniformly fixed at quarterly intervals with proper notice to customers.

Footnote: Is this not daylight robbery?

Citi Sleeps

Citi is not supposed to sleep. But it is not true, anymore. Citi has started to doze off. The Capitalist US had to turn socialist and help Citi with huge package to protect its $306 bn risk assets, in one of the largest bank rescue acts.

Obama says, having China as banker to US Gov’t is not good for their economy, global leadership and financial security. As per the latest statistics available, 20.45% of US treasury securities are held by China (as against 0.5% by India). It is not China alone but a large number of developing and developed countries that have actually propped up the US financial system by investing in the US and the dollar assets. The US deficits running into trillions of dollars are financed by these counties and US is the largest debtor nation today.

Look at Citi’s operations in India. It is growing at 24% even in times of such unprecedented financial turmoil across the globe. Citi’s operations in India are not only profitable (Citi doubled its profits during 2007-08), but it is achieved with less than 1.5% of non-performing assets in its books; an enviable state of affairs for an unhealthy monolith’s well managed operations in one oasis. The credit for this should be equally shared by the bank’s Indian management and the Indian Financial system regulator, the RBI.

The US is the most regulated economy and still has the largest number of bank failures involving some of the Giants in the financial world. Regulation alone cannot achieve what prudence and financial conservatism can do. Even in the worst crisis affecting the East Asian counties in the late 1990s, India remained largely unaffected, because of the prudent policies pursued by RBI and Gov’t of India.

Footnote: Perhaps the day is not far off for the Federal Reserve to seek advice from RBI

About Bankers

Bankers belong to a unique species who will behave in a peculiar manner wherever they are and howsoever irritating it is for others. He will talk always about banks and banking irrespective of the occasion and whether his friends enjoy the 'discourse' or not. There are again classes of bankers - one who is always critical of his bank, thinks everything is wrong with his bank and every other bank does things the right way; some one else thinks he is discriminated against and denied promotion' though he deserves the most, the other fellow should not have been elevated despite being a great performer because 'I' don't like him and so on. There is more pride and prejudice than banking in many bankers. Run of the mill stuff.

Of course there are great bankers too; who think what is good for the bank, good for the employees and customers and for the society at large, They go on to become the change agents for banking. They are the ones who made banking and banks so great (particularly in India, in the present day scenario), less risky and more and more customer friendly. Let this species thrive.

Footnote:He includes she, of course