To pay or not to pay ???

What if your friend had borrowed a lakh of rupees from you and promised to return the money after  one year, you would wait for a year to even start expecting it back. But if he returned the money, say, within a six months, would you be pleasantly surprised, feeling relieved that you got your money back or would you get angry and charge a penalty on your friend for returning the money? 

 

Well, it sounds incredulous that one could get punished for being fastidious in repaying debt but that is exactly what the banks do. If you won a lottery and decide to first get debt-free by repaying your housing loan, you could be in for a rude shock. Banks charge a penalty of 3-5% on the outstanding loan amount.  Penalty is also charged on customers seeking to shift their loans from one bank to another if they found a better deal. Yes, the advertisement of Axis Bank comes to mind, which states that it does not charge a penalty for prepayment. SBI too does not charge a penalty. ICICI Bank charges anywhere between 2-4% plus service tax and surcharge on prepayment.

The RBI Ombudsman has made a proposal to do away with this prepayment penalty on home and auto loan borrowers on floating rates. This is not a rule or a guideline but this is what RBI has ‘suggested’ to the bankers at the meet and said that the onus was on them to implement this suggestion in the interest of customer service, failing which RBI said it will have to issue guidelines. "Sounds good when such arm twisting is in favour of customers!"

The banks might not be happy about this as for them, prepayment means banks have to adjust to asset-liability mismatches arising out of loans against deposits.  When a bank lends for a longer tenure, it also balances it against funds accordingly. Thus when a loan is prepaid, the bank is faced with liabilities which it will need to pay off before time. Also banks want to make up for the additional administrative and processing costs. Many banks charge lower rates in the initial years, hoping to cover up as the tenure increases. And to make up for that loss too, they charge a penalty.

Many banks, do not charge a penalty when prepayment is made through owners funds but somehow get irked and charge a penalty when prepayment is made by borrowing from another bank. The penalty is to act as a deterrent, to dissuade a client from changing banks. Thus RBI has suggested that irrespective of the source of fund for prepayment, when under floating rates, the penalty should be waived.

Charging a penalty on prepayment on floating rates makes no sense (for the customer but enhances margin for banks). It is the bank which has the right to raise or reduce its rates thus similarly, customer should have the right to choose the best competitive rate and thus improve his own balance sheet. Why should the customer suffer while the bank makes merry? Yes, in fixed rate, it makes sense but when 80% of the home loans are on floating interest rates, then does the penalty on prepayment make any sense?

Food for thought :  All these ‘suggestions’ sound good and hopefully banks will toe the line. Or else RBI is sure to step on their toes!