The RBI has kept the repo rate unchanged at 6.5 per cent. This decision follows a series of hike in 250 basis points (bps) since May 2022. In this backdrop, RBI Governor Shaktikanta Das aims to improve transparency for equated monthly instalments (EMIs) of loans on floating rates of interest.
The background to the regulatory announcement on EMIs is that the RBI has been for a long time pushing for transparency and communication. It has at various stages insisted that regulated entities, such as banks communicate clearly to consumers, especially on charges and key facts.
After credit cards and personal loans, the RBI is now setting the same guidelines for home loans as well. While banks have responded very well to this requirement, some work may still need to be done.
Says Adhil Shetty, CEO of BankBazaar.com: “In the last year, as the repo rate moved from four per cent to 6.50 per cent in just a few months, we’ve come across instances of some shocking extensions in home loan tenure. For example, someone who borrowed for 20 years suddenly sees a 30-year tenure jump. The RBI has asked for communication between borrowers and lenders so that such elongations and EMI hikes due to interest rate variations do not come as a shock to the borrower. Interestingly, the RBI is also asking for options to switch to fixed rate loans, which are not typically offered by most banks.”
According to experts, typically, when policy rates and interest rates shift, banks often alter the loan tenure without prior customer notification. Customers are only informed when the EMI amount changes. This underscores the importance of banks following a structured approach and informing customers even when there is a change in tenure.
While specifics have not been provided in the monetary policy reading, such transparency can mean a number of things. For instance, banks may potentially be required to provide borrowers with more detailed information about how their loan EMIs are calculated and how they may vary over time.
According to Anuj Puri, chairman, Anarock Group, a real estate service provider, lenders may also need to provide borrowers with comprehensive information on how the interest rate for their floating rate loan is determined.
This may involve specifying the benchmark rate and explaining how the borrower’s interest rate is derived from the benchmark rate, including any additional margin or spread added by the lender, he says.
“Borrowers could potentially expect a breakdown of their EMI components, including the portion allocated to interest and principal repayment, to help them understand how their monthly payment is distributed and how much is going towards reducing the principal amount owed versus paying interest charges,” he says.
“If the interest rate on a floating rate loan changes, banks may be required in future to promptly notify borrowers about the change, along with the impact it will have on their EMIs. This would allow borrowers to stay informed about any adjustments in their repayment obligations and plan their finances accordingly,” he adds.
The transparency of EMI on floating rate loans can be related to three areas: the benchmark rate, the spread over the benchmark, and the frequency with which the interest rate is reset.
Banks can offer floating-rate loans based on external benchmarks, such as the repo rate or the 10-year government security yield. These rates are already transparent because they are external to banks. However, in most cases, banks offer floating rate loans based on the internal benchmarks such as the Marginal Cost of Funds based Lending Rates (MCLR). While the RBI has established an objective framework for calculating MCLR for individual banks, there is room for subjectivity in determining these rates.
Says Sujan Hajra, chief economist and executive director, Anand Rathi Shares and Stock Brokers: “The governor may be implying that these internally determined rates should be more objective and, thus transparent. Further, banks have some leeway in linking different types of loans to different benchmarks. Transparency can also be used to decide on a consistent approach to determining specific benchmarks for specific types of loans.”
He adds: “The banks have even more leeway in determining the spread over the benchmark for extending a loan to a specific customer. The spread is determined by a number of factors, including corporate credit rating and individual credit score. The governor’s emphasis on transparency is likely to be primarily in the context of objective determination of the spread. The banks use various periodicities in resetting interest rates on loans, ranging from daily to quarterly. Transparency appears to be needed in this area as well.”
Says Raj Khosla, founder and managing director, MyMoneyMantra.com: “The RBI chief has announced a plan to bring greater transparency to EMI of floating rate loans, a crucial issue affecting many borrowers. At present, when there’s a change in the repo rate, banks may sometime alter the loan tenure without notifying the borrower, even extending the terms to 35-40 years without consent. This proposal seeks to address this practice by mandating banks to inform borrowers of any change in interest rates, allowing them the choice to either increase the EMI or the tenure.”
Furthermore, banks will be required to enhance transparency by disclosing their interest revision cycles, overall cost effects, and linkage to benchmark rates and margins.
“This initiative is geared towards empowering borrowers to make informed decisions, and to choose between maintaining the same tenure with a higher EMI, or, extending the tenure with the same EMI when rate changes occur. By fostering clear communication and openness between banks and borrowers, these measures are poised to build trust, reduce confusion, and bring about customer-centric practices in the financial sector. The move marks an important step towards aligning the interests of banks and borrowers, promoting integrity and ethical lending practices within the industry,” he adds.
