Why is the RBI against teaser home loan rates?

The Reserve Bank of India is in borrower-protection mode. Recently, it asked banks to link all loans to external benchmarks to provide parity in the cost of funds for the borrowers and now, reports suggest that the banks’ plan to find a way around this through teaser-loans may not work. It’s being reported that the RBI may not be in favor of re-introducing teaser loans which are essentially loans that start with a fixed rate and jump to market rates a few years down the line when the interest rates start to climb.

State Bank of India Chairman Rajnish Kumar had recently hinted at the possibility of re-introducing these loans when he said that the bank will be seeking clarifications from the RBI to see if it can home loans with fixed rates at the start and convert them into floating rates later.

What are teaser loans?

As the unofficial name suggests, teaser loans are home loans which basically ‘tease’ people into borrowing more as they offer a cheap interest rate, to begin with, and when customers have taken the loan, the interest rates reset to market floating rates which are usually higher. Bankers usually don’t use the term teaser loans though and call them fixed-cum-floating rate loans. These loans usually get back in vogue every time interest rates are falling – a situation being observed currently too.

The first such loans were launched by SBI in 2009 to boost its loan book and provide funding to the housing construction industry. The loans offered by SBI were fixed at just eight percent for the first year and nine percent for the second and third years. The loan would then shift to floating interest rates. A number of other banks also offered these loans but the RBI came down heavily on such a practice as buyers felt cheated.

Why is the RBI unhappy with teaser loans?

Teaser loans have not always been accepted by the regulator. Banks were seen to be using low-interest rates to lure customers into taking more credit and once the rates rose, these loans were moved to market rates delivering a shock to the borrowers who saw their EMIs shoot up suddenly.

To discourage this practice, RBI even mandated higher provisioning for such loans. Provisioning is the amount of money set aside for a loan in case it turns into a non-performing asset. In December 2010, the banking regulator even said that “this practice raises concern as some borrowers may find it difficult to service the loans once the normal interest rate, which is higher than the applicable rate in the initial years becomes effective.”

It further stated that:

“It has been observed that many banks at the time of the initial loan appraisal do not take into account the repaying capacity of the borrower at normal lending rates.”

So, why do banks like SBI want it back?

It all started with the RBI’s recent move of asking banks to necessarily link their retail and SME loans to an external benchmark. The external benchmarking is being done to ensure that lending rates are lower than the prevailing rates. This is one of the ways the RBI is trying to ensure that it’s monetary policy actions such as rate cuts are transmitted through the economy. The benchmarks for loans can be:

1. RBIs policy repo rate. Repo rate is the rate at which the central bank lends money to other banks.
2. Government of India three-month Treasury Bill Yield published by the Financial Benchmarks India Private Ltd (FBIL).
3. Government of India six-month Treasury Bill Yield published by the FBIL.
4. Any other benchmark market interest rate published by the FBIL.

The issue with this kind of benchmarking is that while banks will have to move their interest rates in line with market rates, they will still be providing deposits at a fixed rate. Meanwhile, teaser loans can help banks have that flexibility of increasing their interest income if the rates rise and providing fully flexible market-linked loans doesn’t bode well as rates are on a downward trend.

What happens if the RBI indeed stops SBI in its tracks?

There are some who speculate that teaser loans may not see the light of the day, after all. In such a case, banks will be left with limited options as external benchmarking has to necessarily happen from October 1 with a mandatory reset of rates every three months. This means that banks will have to either find more innovative ways to protect their interest margins or look beyond lending to future-proof their cash flows.

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