The Reserve Bank of India (RBI) plans to direct banks to stop levying penalty on pre-payment of retail loans, heeding to a long-standing demand of borrowers availing of floating rate loans who find benefits of periodical interest rate cuts eluding them.
“The right to avail of loans at lower rates of interest should not be curtailed by prepayment penalties. We will direct banks to do away with the prepayment penalty in case of loans disbursed in future,” said an RBI official. However, the banking regulator is yet to decide on whether this benefit should be given to existing borrowers, he said, requesting anonymity.
If this happens, there will be a huge renewal of interest in home loans, but it can only happen if the bond market is eased up considerably. Interest rate futures need to go up to 20 years, and shorting bonds has got to get easier. This is so the term mismatch of banks (borrowing short and lending long) can be hedged appropriately. Repossession of homes on default should become faster too – that is happening anyhow.
The hit will be taken by private banks (not all, Axis bank is already offering loans under 9% with no prepayment penalty) and by NBFCs like HDFC and LIC Housing Finance. Securitization may help some of them but the RBI isn’t too keen on making it a diseased market on steroids like it is abroad. (i.e. there will continue to be a lot of regulation)
They should mandate a single PLR per bank too, and a violation should make all home loans carry the highest risk weights (destroys leverage and the bank’s profit margins). But anything to make the market more transparent and less dishonest is a good thing. Banks can tighten up and refuse to lend to real estate – but hey, where else can they lend?