Will RBI be forced to issue a regulation on Pre-payment charges like NHB?

Recently SBI and ICICI Bank have also announced that they are waiving pre-payment charges on floating rate home loans whereas Axis Bank anyways has not had pre-payment charges on floating rate home loans for some time now. This would seem to suggest that all floating rate loans have no exit charges now. But unfortunately things are not exactly what they seem.

We know that National Housing Bank (NHB) had stolen a march over its parent RBI in passing a regulation that pre-payment penalty cannot be charged by housing finance companies in case of loans that are on a floating interest rate basis irrespective of the source of such repayment (even if it is by way of transfer of loan to another lender).

Since 98%+ of the borrowers have taken home loans on floating rate basis this will have a beneficial impact on all home loan consumers who have taken loans from Housing finance companies (like HDFC Ltd., LIC Housing Finance and Dewan Housing Finance Ltd. etc.). This will be especially useful for people who have taken these loans from these entities before 2010 who are paying interest rates as high as 12-14% even though new customers are given 10.75% - 11.25 % by the same lenders.

But unlike the housing finance companies where the regulator NHB ( National Housing Bank) has mandated that pre-payment charges cannot be levied on floating rate housing loans (irrespective of the source of such repayment) RBI which regulates banks is reluctant to issue such a regulation. RBI is instead leaning on the banks and nudging the industry association IBA to get an industry consensus on this matter. SBI (for all floating rate loans) and Axis Bank (for floating rate home loans only) had already moved to a no pre-payment charge regime even before RBI started leaning in favour of abolishing pre-payment charges. So far the only result from RBI’s behind the scenes pressure has been on ICICI which has announced that it will not charge pre-payment charges on floating rate home loans. Of course with ICICI coming on board (in addition to HDFC, SBI and LIC Housing Finance) it covers more than 70%+ of all outstanding home loans.

For those who came in late it is common practice in India for existing floating rate loan customers to pay interest rates far in excess of the rates paid by the new customers with similar risk profiles and for similar loans from the same bank. This has become the most significant consumer grievance and the pre-payment charges only creates an exit barrier for consumers to shift their loans to another lender who is willing to provide the loan for a much lower rate. Whilst various devices such as the Base Rate mechanism are being tested out to instill some degree of equality in treatment of existing consumers with new consumers there is now regulatory consensus that the exit barriers in terms of pre-payment charges payable to the existing lender needs to be removed.

The impact of not having an official regulation on pre-payment charges is twofold. Firstly it has so far had no impact on other PSU, private and foreign banks whose consumers continue to pay a pre-payment penalty when they shift their loan to another bank.

Secondly the concession continues to be narrowly targeted on only home loan consumers. ICICI and Axis bank for example continue to charge a pre-payment penalty on floating rate Car loans, Loan against property, etc. Obviously if the pre-payment penalty is unfair for home loan consumers the same logic applies equally to other floating rate loans as well. How could they escape regulator’s attention?

To sum it up, the impact of not having a regulatory framework for this requirement on which all lenders have shown reluctance only means that whilst the majority consumers may get the benefit other consumers who are either with the smaller banks or on other loan products will continue to suffer from the unfair treatment of existing consumers.
I think RBI has given more than enough time to the industry to come up with this on their own and in the face of the reluctance shown by remaining players, it will be forced to bring in an enforceable regulation in this regard sooner rather than later.  This will remove one big irritant for loan consumers seeking to transfer their loans from one lender to another and also ensure that (at least for alert consumers) banks cannot overcharge existing consumers as compared to their new customers.

We only hope RBI acts soon on the matter.