Base lending rates have been coming down in the past year but that wouldn't benefit those with loans at a fixed interest rate. The banks have a solution.
Ankit Chaturvedi started his day as any other. He reached his office desk at 9 am and started sorting out his schedule. The month-end was coming near and the loan repayments were back on his mind. Just then, he received a phone call from an unknown number.
“Hello, am I talking to Mr Chaturvedi?” boomed the voice on the other end. Thinking it might be one of those tele-marketing calls, Chaturvedi replied in positive, albeit half-heartedly.
“Sir, I am calling from your bank. You have a personal loan with us,” the voice continued.
“Yes, I do,” Chaturvedi replied, this time, a bit more alert.
“Sir, as you know, the interest rates have been coming down over the past few months and you have a fixed interest rate loan. You are a valued customer for the bank, so we are offering you a reduction in your interest rates. Would you like to avail the offer?”
“Of course!” exclaimed Chaturvedi, reminiscing about the time he'd agreed to pay 16% interest rate on his personal loan because of an urgent need.
The repo rate, or the base rate at which the central bank loans money to retail banks in India was at 8% in January last year. Since then, the Reserve Bank of India (RBI), has substantially brought down the interest rates, with the latest cut of 25 basis points coming on Tuesday, April 5, 2016. The repo rate, as on the date, stands at 6.5%.
Naturally, the interest rates, too, have started to come down — although — not as much as the cut in repo. This has been a bone of contention for the RBI and its governor Raghuram Rajan as well.
During the first bi-monthly monetary policy announcement of the fiscal on Tuesday, Rajan said that the focus is on the transmission of these interest rate cuts. To facilitate this, the central bank has taken other measures as well, including linking loans to MCLR (Marginal Cost of Lending Funds). What this means is that the interest rates on loans will now be linked to the benchmark rates, bringing them down more swiftly in case of downward revisions.
ICICI Bank, HDFC Bank, IDBI Bank, Axis Bank, Punjab National Bank, State Bank of India, Andhra Bank, Bank of India, all cut their interest rates in the last year, making car and home loans cheaper. However, there is still room for more cuts, some reports suggest, up to 75 basis points more. One basis point is 0.01%.
Banks offer loans on fixed or floating interest rates. Long-term loans, like home loans, are usually linked to floating rates and car or personal loans are fixed rate loans.
Simply put, if the RBI cuts repo rates, the banks follow suit and your monthly loan payments to the bank comes down in case of a home loan. However, these rate cuts have no bearing on car or personal loans as they are based on a fixed rate of interest for the entire lifecycle of a loan.
Generally, the rate of interest for a personal loan are higher than the benchmark rates. Currently, personal loans offered by Indian banks are available at fixed interest rates ranging from 14-16%, more than a car or a home loan. The repo rate as on Tuesday, is at 6.5%.
It is this fall in interest rate that the banks want to cash-in on.
The bank executive, on the phone-line with Chaturvedi, continued, “Sir, as I said, the bank is offering you a revised and lower rate of interest for your personal loan. However, to avail that, you will have to take a ‘top-up’. The extra loan will be at lower rate than your earlier loan and so, your average cost of borrowing will come down,” the man said.
Chaturvedi felt cheated and rightly so.
The bank effectively tried to lure him into taking an additional personal loan in order to bring his interest rate down to match the new rates that are lower than when he'd taken the loan a year ago.
A senior official from one of the largest private sector banks in India agreed to this recent practice. The official, who declined to be named in the story, said, “Every bank offers top-up loans depending on the customer profile, his/ her relationship with the bank, and their credibility."
Clearly, banks have found a way to dole out more loans to their customers.
Offering a ‘top-up’ loan isn’t a bad practice per se but packaging it as a solution to lower your rate of interest by offering more loan is certainly a grey area.
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