In a move to protect borrowers from interest rate fluctuations and reduce the burden of equated monthly instalments (EMIs), a Reserve Bank of India (RBI) committee has suggested banks offer loan products with a repayment period of 30 years.
Such loans, goes the proposal, could have an interest reset provision every seven to 10 years but lenders should be mindful of the customer's interest and not violate regulatory guidelines on the base rate.
"The Indian financial system has G-secs (government securities) up to 30 years and 30-year bonds by banks. Banks could, therefore, make efforts to offer longer-tenor fixed rate loans, say up to 30 years, which would help reduce the EMIs of borrowers," says the K K Vohra panel's final report, presented on Tuesday. It was appointed to study the feasibility of introducing more long-term fixed interest rate loan products.
The panel feels banks could have the option to fix a reasonable cap and floor (200 or 300 basis points) at the time of reset in relation to the interest rate originally charged to the borrower. The suggestion is made to protect both customers and banks from the risks arising out of adverse movements in interest rates.
Banks have also been advised to introduce hybrid loan products, having both fixed and floating interest rate loans with a higher proportion of the former.
Fixed rate loan products were popular before 2000 and lost their sheen once interest rates started to fall, which made banks focus on floating rate products. The panel has observed most home loan products are generally on a 15-25 year maturity and floating in nature. Automobile loans, of five to seven years' tenure, mostly offer fixed rates.
Since bank deposits are mostly below five years, emphasing on longer term fixed rate loan products might create an asset-liability mismatch for banks. So, the panel suggested banks should issue more long-term bonds, with a minimum maturity of five years, to the extent of their exposure to the infrastructure sector (minimum residual maturity of five years).
"Banks should popularise fixed deposit schemes with tenors above five years, as these are eligible for tax exemption. This would to some extent meet the long-term funding requirement of banks," the panel said.
Though RBI has banned a pre-payment penalty on floating rate loans, the panel has suggested banks be allowed to charge one on fixed rate loan products, on only the amount due. This should be reasonable, so that it does not act as a disincentive for fixed rate loan borrowers.