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Teaser loans a rude shock for many homebuyers when interest rates shoot up; RBI right to decline SBI's idea from Day One

Dinesh Unnikrishnan

'Teaser loans' are back on the discussion table. Country's largest lender, SBI wants it but the Reserve Bank is reportedly not keen to let banks bring back this product. Back in 2010, State Bank of India (SBI) had introduced teaser loans but rolled back after just a year following disapproval from the Reserve Bank of India (RBI).

What are these loans? Teaser loans would carry a lower fixed rate of interest in the initial years which will jump to a higher floating rate after a specific period. The RBI was concerned that such a product with an attractive lower rate in the initial years would lure borrowers who will subsequently get a shocker in the second phase when the rate of interest jumps significantly adding to their repayment burden. At this stage, the borrower's interest rate calculations can go wrong, adding to his financial burden.

In 2010, shortly after the launch of these products, the RBI had imposed higher risk weight on such loans to discourage banks from offering this product to borrowers. This made these loans unviable to banks and they withdrew it in 2011.

What happened now? Recently, SBI chairman Rajnish Kumar pitched for these loans again saying the bank will seek clarification from the central bank on whether the bank can launch home loans carrying fixed rates at the beginning that will switch to floating rates after a while€"which is what teaser loans did.

Banks perhaps see this as a way to revive demand in the loan market and stay competitive especially in the backdrop of the RBI deadline approaching for the switch to external benchmarking of loans from the present marginal cost of funds based lending rate (MCLR) structure.

In fact, this isn't the first time SBI is making a case for return on teaser loans. Almost all SBI chiefs including Kumar's predecessor, Arundhati Bhattacharya, too, had said that there is room for teaser loan products in the market. But the RBI never bought the idea of luring the customer with a cheaper loan that is, in reality, was not cheap at all.

RBI's reported decision to not allow teaser loans is welcome as this product confuses the potential borrower about the actual cost of the loan and is simply putting the risk to a later date. That's not a fair deal for a normal borrower.

But no matter what the RBI says, banks have always been finding tricks to tinker with their final lending rates and protect the margin. Because of this, the borrower ended up paying higher interest equated monthly installments (EMIs) whenever RBI hiked policy rates but rarely benefited in a tangible manner whenever the central bank cut rates.

Since the beginning of this rate cut cycle, the RBI has lowered the repo rate, at which it lends short term funds to banks, by over 110 basis points (one bps is one-hundredth of a percentage point) but banks have passed on only 30-40 bps to the borrowers.

Will the new external benchmarking of loans that will become mandatory from 1 October change the scenario? Note that this is the latest weapon the RBI using to nudge banks to do a proper monetary transmission.

In the past too, the RBI has tried several methodologies/internal benchmarking systems to bring in transparency and make banks listen to its rate cues. These include the earlier BPLR (benchmark prime lending rate) system to the base rate (minimum lending rate) and later to the MCLR-based calculation was nothing but to bring in more transparency in the interest rate setting process.

But banks have always found a way out. Even the external benchmarking leaves room for maneuvering for banks since the lenders can decide the spread or risk premium over the benchmark rate. Banks will also attach processing charges etc from the borrower. In other words, the external benchmarks need to be uniform for a particular category of loans but that won't be the final rate at which a borrower gets the loan.

Instead of funding cost, banks will have to now link loan rates to an external benchmark, say repo, rate. This will impact the flexibility of banks in adjusting rates compared with the MCLR regime. To protect their margins, banks will be then forced to increase the spread significantly over the benchmark rate.

RBI has been left as a silent spectator all these years when the banks constantly found ways to find a way around to not follow signals for adequate monetary transmission. It is unlikely that the external benchmarking will bring any significant change in this story. That's why rating agency Moody's Investors Services has said the new norms are credit negative for banks.

SBI's quest for 'teaser' loans shows banks are in a panic state ahead of the new rules on external benchmarking in a bid to protect interest margins. The RBI is right in killing the idea, once again, in the interest of the common borrower.

Also See: ICICI Bank lowers lending rates by 10 bps effective 1 September; lender's one-year MCLR come down to 8.55%

RBI makes it mandatory for banks to link retail loans for housing, MSMEs with external benchmarks from 1 October

SBI again cuts lending rates by 10 bps ahead of festivals, new rates effective from tomorrow

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