Banks issued notice for seeking details of interest rates increases on home loans

Last month a notice have been sent to about half a dozen banks by the Monopolies and Restrictive Trade Practices Commission (MRTPC) seeking details on how they had determined the interest rate increases on their housing loans.

This reflects the concern expressed by the Reserve Bank of India (RBI) in its mid-term policy review in October 2007 on transparency and fairness in the pricing of housing loans.

In 2007-08, most banks had lowered the lending rates but only for the new housing loan borrowers, because revising the interest rates for existing customers require banks to first revise their benchmark prime lending rates (PLRs) to which the housing loan interest rates are linked.

However, some public sector banks have now lowered the interest rates for both existing and new borrowers. But they have still kept the benchmark PLR unchanged, reflecting the increasing irrelevance of the PLR as a benchmark rate.

Whereas the PLR was supposed to be the rate at which a bank would lend to its best borrowers; banks’ prime borrowers are now availing loans at interest rates that are 25% lower than the PLR.

In spite of fall in the deposit rates and lowering cost of funds since April 2007, banks did not change their PLRs.

In its report on the trend and progress of banking in India for 2006-07, the RBI, had observed that the share of lending at rates below the PLR (sub-PLR lending) had gone up by 79% at the end of March 2007 from 69% a year earlier.

In 2001, the RBI allowed lending at rates below PLRs so it is no longer essential to revise the PLR to reduce effective loan rates. In April 2003, the RBI proposed a single benchmark PLR to address the downward stickiness in lending rates.

While the general practice of having multiple prime lending rates for working capital and term loans had made the pricing of loans complex.

Banks are supposed to take the approval of their boards in fixing their BPLR, based on cost of funds, operating expenses and a minimum margin to meet the regulatory and provisioning norms and a profit margin.

While the lending rates did come down initially, reflecting the overall decline in interest rates over the last three years, the BPLRs, quick to rise, have shown reluctance in climbing down.

In case of floating rate loans, banks had the option to either link the interest rates to BPLRs or market the benchmark rate.

In its mid-term review for 2005, RBI had called for a review of the BPLR system noting that competition had forced the pricing of a significant proportion of bank loans far out of alignment with BPLRs and in a non-transparent manner.

It was supposed that loans to companies were being under-priced, while small-scale industries and agriculture were being over-charged. So RBI asked banks to analyze the costs incurred for lending to various segments.

Since then, the RBI had repeatedly expressed its concerns, accompanied with threats of regulatory action if banks did not ensure transparency and fairness in the pricing of loans.

In their pre-monetary policy meeting with the RBI in January 2008, banks did convey the absence of a market-determined benchmark rate to price floating rate loans.

“We told the RBI about our need for a true market indicator for the benchmark rates to develop floating rate products,” said a banker present at the meeting.

Bankers have marked the need for a market-determined benchmark rate. Banks are only asking for flexibility in determining the interest rates on the lending side, as well as on the deposits.

Banks have not been able to find the takers for the floating rate deposits since fixed deposits are a preferred option. Banks are assessing the feasibility of having different interest rate deposit products.

A customer who wants the option of withdrawing the deposit before maturity should be offered a particular interest rate and; a borrower who forgoes the option might be given a higher interest rate.

The retail committee of banks under the guidance of the Indian Banks’ Association is studying the issue. Meeting is likely to be held this month to discuss the establishment of benchmarks for floating interest rates.

Banks cannot argue that they are exposed to a similar interest rate risk on the deposit and lending side. While banks provide housing loans with an average maturity of 10-15 years, the deposits are of 1-3 year maturity and are automatically re-priced when they come up for maturity.

A working group has been formed by RBI to study the development of an inter-bank term money market in India. The inter-bank term money market, where banks can borrow funds from each other for 15 days to one year, is very low as the daily volumes are currently just a few hundred crore rupees.