What if a kilogram was a variable? Or a kilometre? How’d you react if the vendor was free to decide what a kg would measure today? The vendor could then choose to give you five mangoes a kg when he bought mangoes at Rs25 a kg, he could define a kilogram such that you got just four when the price he faced went up to Rs30 a kg. And if prices fell to Rs10 a kg, he had the power to define the kilogram at five mangoes a kg.
You paid in terms of fewer mangoes when prices rose but didn’t get the upside of more mangoes when prices fell. Outrage can probably begin to describe the common minimum response. So how’s it that the Indian home mortgage industry gets away with doing this so blatantly?
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When interest rates as measured by the repo rate, or the rate at which banks borrow money from the Reserve Bank of India, hit 9% in August, banks were quick to pass on the increase to home loan customers. Some banks informed of the increase in tenure and equated monthly instalments (EMI), others just carried it out silently. There were instances of people finding out that their EMI was now a perpetuity.
Six months later, the repo is now down 400 basis points to 5%, the reverse journey in home loan rates has not happened. Banks and housing finance companies have to be arm twisted by the government and savvy customers to reduce rates. A quick dip-stick survey of friends and family shows that existing home loan borrowers are still paying rates in double digits while the rates facing new customers are down to as low as 8.75% floating from LIC Housing Finance Ltd.
What’s going on? How do banks get away with this dual pricing structure? The answer is in the definition of a floating rate, what it is pegged to and who sets this anchor rate. The home loan rate will float in relation to something called a prime lending rate (PLR). Each bank sets its own PLR and links the home loan rate to it.
So if State Bank of India has a PLR called State Bank advance rate (SBAR) of 12.25%, its Rs30 lakh loan for 20 years will be at SBAR minus 1.50, or 10.75%, a year. The PLR in this formula is the variable which is supposed to float up when there is an overall high interest rate regime and float down when interest rates fall, pulling the home loan rate tagged to it with it.
India has seen that the PLRs tend to float up fast but the reverse is not true. Instead of lowering the PLR, banks will shave more from the PLR for new customers. So if existing customers are at PLR minus two, new customers will be at PLR minus four. This leaves the average customer feeling cheated and dissatisfied.
The solution to this is so simple that one wonders why it is taking so long for the regulator to implement it. Make the PLR an industry standard and then allow all banks to price their loans and customers in any way that they think fit for their businesses.
A benchmark cannot be an internal decision of a corporation, it must be an industry standard that is arrived at independently. Though the Indian Banks Association (IBA) has been talking about getting the top 10 Indian banks to move to a Mibor-linked PLR, it is yet just talk. (The National Stock Exchange’s Mumbai inter-bank offer rate is used as a benchmark rate for majority of deals struck for interest rate swaps, forward rate agreements, floating rate debentures and term deposits.)
The only two examples of third-party, benchmark-linked home loans were quickly withdrawn. One used the one-year fixed-deposit rate of the own bank as a benchmark and the other used the Mibor, the Indian counterpart to the London inter-bank offer rate (Libor) as an independent benchmark.
This is not an argument for a government-controlled home mortgage rate regime. To the contrary, based on my credit rating, my repaying capacity and my home loan tenure and size, give me a rate that applies to my situation. And this can vary with each customer. There can be a thousand rates for a thousand customers. But there is one independent benchmark to which all rates are pegged.
The blow that free markets have received in the past two years has washed up on the doors of regulators. Markets will work not because profit-seeking corporations will do the right thing, but because the cost of violating rules is higher than the profit they seek to make by bending rules.
In the absence of effective regulatory direction, it is a race to the bottom. The corporation with the loosest sense of ethics and morals wins. In the absence of such regulation, the only option you and I have is to threaten our banks with refinancing the loan. Try it. They drop rates faster than you can say refinance!
Monika Halan is a certified financial planner and policy analyst in the area of financial literacy and intermediation. Your comments and personal finance queries are welcome at firstname.lastname@example.org