'Pre-payment penalty should be reasonable'

Last Updated: Sat, Nov 10, 2012 04:11 hrs

The Reserve Bank of India (RBI) on Friday placed on its website the draft report of the ‘committee to assess the feasibility of introducing more long-term fixed interest rate loan products by banks’. The report has been placed for public comments.

According to the recommendations, banks should charge pre-payment penalty on fixed rate loan products to the extent of the amount due only, and not on the initial loan amount sanctioned as some banks are doing. It should also be reasonable. Moreover, the pre-payment penalty could be graded, based on the period after which the loan is repaid - like five years, 10 years and so on.

In addition to the plain basic fixed rate loan product for long tenor, the draft report suggests banks might also introduce a hybrid loan product having both fixed and floating interest rate loans, with a higher proportion of fixed rate loan.

It also recommends banks to popularise the fixed deposit schemes with tenors of more than five years as these are eligible for tax exemption. This would, to some extent, meet the long-term funding requirement of banks, which would then be in a better position to extend long-term fixed rate loans.

The draft report also suggests banks make efforts to elongate the tenor of fixed rate loan, say up to 30 years (without a reset clause), which would help reduce the equated monthly instalment (EMI) of borrowers. Since the financial system has government securities up to 30 years, banks could raise 30-year bonds and price G-secs based on the yield of 30-year G-sec.

Another recommendation is that banks periodically review the premium charged for new long-term fixed rate loans and not charge off-market rates on these.

According to the recommendations, banks may introduce and popularise fixed rate long-term loan products with interest re-set provisions. This can be between seven and 10 years till the maturity of the loan, in addition to the plain basic fixed rate loan product for long tenor.

The draft report also suggested that large institutional investors such as pension funds, provident funds, insurance companies, etc. should be encouraged to invest in bonds issued by banks, by suitably amending the relevant investment guidelines.

The recommendations also suggest that National Housing Bank (NHB) may examine the feasibility of extending its refinancing scheme to banks offering long-term fixed housing loans products to their customers other than low-income households. Further, NHB may explore issuing long-term housing bonds for channelising the long-term resources into the housing sector.

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