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By Neha Dasgupta and Shamik Paul
MUMBAI (Reuters) - The Reserve Bank of India has urged banks to offer more long-term fixed-rate loan products in contrast to the current bias of lenders towards floating-rate products, to protect borrowers from interest rate fluctuations.
To help banks move towards fixed-rate products, the RBI suggests banks could reset interest rates after a period of 7 to 10 years instead of charging an exorbitant flat rate for the entire tenure, said an RBI panel's report on assessing feasibility of introducing more long-term fixed-rate loan products.
"Interest rate fluctuations adversely affect the affordability of housing loans and enhance the risk of default by the borrowers," the central bank panel report said on Tuesday.
"Thus, the floating interest rate over the long period of the loan carries risk for the borrowers (EMIs may increase) as well as for the lenders (credit risk)."
Indian banks have been gradually shifting towards floating-rate loans from fixed rate in the absence of expertise to price such long-term products, the RBI said.
In 2012, the proportion of fixed-rate products to total loans shrank to 25 percent from 32 percent in 2010 while floating rate products grew to 75 percent from 68 percent, the panel said.
The central bank prodded banks to re-launch loan products that were partially fixed rate and also proposed allowing banks to raise long-term bonds to finance their long-term fixed-rate loan products.
The RBI panel also urged banks to launch deposits above 5-year term for extending long-term fixed rate loans.
The central bank had allowed banks to levy pre-payment penalty charges on fixed-rate loans while the same is not allowed for floating-rate loans.
"Volatility in interest rates have made risk management from the interest rate point of view challenging for banks. So, with long-term funds and long-term lending, there will be better risk management and also better margins," said M. Narendra, chairman and managing director, Indian Overseas Bank
Banks are already allowed to raise long-term bonds to the extent of their exposure to infrastructure sector with residual maturity of above five years.
However, most banks have not taken recourse to such issuances, the central bank panel noted.
"This would release resources of the banks locked up in infrastructure loans which can be deployed for extending long-term fixed-rate loan products. This will also facilitate banks to extend fixed-rate loan products ranging from 15 to 20 years," the report said.
(Editing by Gopakumar Warrier)