Why home loan borrowers are celebrating Subbarao's policy

The Reserve Bank of India today quite benevolently cut the repo rate by 50 basis points bringing it down from 8.5 percent to 8 percent. But apart from that there were other crucial announcements D Subbarao had to make. There were quite a few provisions for retail customers for banks to improve banking habits and norms, and encourage financial inclusion.

RBI today mandated that all banks would have to abolish foreclosure or pre-payment penalties on home loans on a floating interest rate basis. RBI said if such charges are abolished, there will be less discrimination between new and existing home loan customers for banks. There will be better competition among banks which will lead to finer pricing of home loans.

The instructions came following recommendations of the Damodaran Committee which observed that foreclosure charges levied by banks on prepayment of home loans needed to be done away with as banks hardly passed on the benefits of lower interest rates to the existing borrowers in a falling interest rate scenario. The charges are also seen as a “restrictive practice deterring the borrowers from switching over to cheaper available source.”

RBI will give detailed guidelines regarding this. Banks like ICICI Bank and SBI should be ideally affected as they have large home loan portfolio. However, both the bank managements clarified that big banks have already abolished the prepayment penalty charges sometime back and will therefore have no effect on them now.

This abolition of foreclosure charges apply only to floating rate loans. However, RBI has also admitted that though deposits rates are mostly fixed, the retail loan products especially home loans have fluctuating interests. This means increasing risks for the borrowers for the uncertainty of the interest to be paid. RBI therefore now wants banks to introduce more fixed rate loan products as banks might be in a better situation to handle the interest rate risk.

RBI has therefore proposed to set up a Working Group to assess the feasibility of introducing more long-term fixed interest rate loan products by banks.