The Reserve Bank of India (RBI) has come down heavily on banks for charging pre-payment penalty on dual-rate home loans, and has issued a circular banning such a penalty.
Earlier, RBI had barred banks from charging pre-payment penalty on floating-rate loans, which gave customers the incentive to shift their loans from one bank to another, to take advantage of the interest rate differential. The central bank said customers will be given the option to switch banks, and as banks are in a better position to hedge interest rate as instruments are available to them, the interest risk should be borne by banks.
However, the previous RBI guidelines had not clarified if such a levy can be applicable on dual rate home loans.
According to central banking sources, some of the large banks were taking advantage of the lack of clarity and levying pre-payment penalty on dual rate home loan schemes - which are also known as teaser loan schemes. Interest rate on such loans is fixed during the initial years, after which the rate became floating as it gets linked to the base rate - the benchmark lending rate of banks.
Following a number of customer complaints that banks are charging the penalty on dual rate home loans, the regulator issued fresh guidelines to banks asking these to refrain from such activities.
The National Housing Bank, the regulator for housing finance companies, had also banned pre-payment penalties on the dual rate loans.
Teaser loans were pioneered and popularised by State Bank of India in early 2009 to deploy excess liquidity. The scheme - a brainwave of former chairman O P Bhatt - helped the lender increase its market share in home and auto loans.
Other lenders had no option but to follow suit.
But the product had drawn flak from the RBI, which constantly asked the banks to withdraw the product. Finally, in order to discourage the product, the central bank increased standard asset provisioning requirement for teaser loans by five times to two per cent.