The chairman of the country’s largest lender, State Bank of India (SBI), O.P. Bhatt, seems to be redefining the rules of retail lending. Consumer loans had spurred bank credit in the past few years, before economic growth started slowing in 2008, prompting aggressive retail players to shrink assets such as mortgages and auto loans. After freezing the home loan rate at 8% for the first year, SBI last week froze its loan rate for new cars at 10%, again for the first year.
While competitors see the cuts as part of a strategy to ramp up SBI’s market share in retail loans, some analysts warn of pressure building up on the bank’s balance sheet because of such low-priced loans. The bank’s official stance is that the lowering of interest rates will spur demand and arrest the slowdown in economic growth. Let’s take a closer look at the impact of such actions on the economy, the bank and consumers.
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The window for auto loans opens on 23 February and closes on 31 May. The home loan window is even shorter—three months, between February and April. So those who want to buy flats and cars with SBI loans will have to do so now. Can the low first-year interest rate alone push consumers to take the plunge? The fence-sitters may get enticed by the bait of low rates, but there may not be a huge rush unless real estate developers and auto makers slash prices. And, if consumers indeed rush to buy homes and cars to take advantage of the low interest rates, real estate developers and car makers may see this as an opportunity and refuse to cut prices.
Theoretically, of course, it will help the economy as steel and cement sectors will benefit if more flats are sold and jobless construction workers may head back to the cities from rural India. Similarly, if more cars are sold, car makers will be able to get rid of inventories that have been piling up. That will improve their cash flow and they will be able to pay vendors and ancillary units complaining of delayed payments. Cheap loans can affect a bank’s profitability as the net interest margin, or the difference between what a bank pays for funds and earns on loans, shrinks. But currently there aren’t too many avenues before banks to disburse high-yielding loans. The year-on-year growth in bank credit had fallen to 19.3% at end-January, from about 23% last year, and at least 30% in the past few years.
Banks are flush with funds and they are earning 4% by parking their excess liquidity with the Reserve Bank of India, or RBI. So, 8% return on home loans and 10% on auto loans are any day better than the 4% banks earn by keeping excess cash with RBI. Also, such cheap rates are frozen only for a year and SBI will earn more from next year. However, a very aggressive push for such loans may lead to the creation of bad assets. If a customer is tempted to buy a flat or a car today, driven by low rates, and is not able to service the loan in the future, the bank will have to provide money against such loans. If the economic slowdown intensifies, leading to many more job losses, SBI may see growing bad assets in retail loans.
SBI has frozen the auto loan rate at 10% for one year. From the second year, a customer will have to pay 11.5%. If the auto loan rates of other banks such as ICICI Bank Ltd and HDFC Bank Ltd do not go down from the current level, an SBI customer will pay less over the entire tenure of such loans compared with the customers of other banks. This may not be the case with home loans. The SBI scheme offers a fixed rate of 8% for one year from the date of disbursement. In the next four years, between the second year and fifth year, a customer pays a fixed rate of 8.5% for loans up to Rs5 lakh and 9.25% for loans between Rs5 lakh and Rs20 lakh. From the sixth year, a customer has the option of continuing at fixed rates or floating rate prevailing at that time. A customer can also shift to the fixed or floating rate from the second year, after paying 8% in the first year. If the interest rates fall from the current level, a customer who locks herself in for five years will be a loser.
The home loan as a product has the maximum scope for innovation. In 2003, Dutch Bank ABN Amro Holding NV’s Indian unit had offered home loans at 6% fixed interest rate for the first year and 6.5% in the second year, irrespective of the loan tenure and amount. The bank claimed to have launched the scheme after extensive customer research that revealed that one of the biggest concerns of the home buyer has been to manage stress in the initial stage of the loan period given the expenses involved in setting up a new home. IDBI Bank Ltd, the erstwhile new private bank that subsequently got merged with the financial institution Industrial Development Bank of India, offered 110% of the price of a flat as a home loan to take care of the registration expenses. IDBI Bank in 2002 also offered gold worth Rs2 lakh to home loan customers with conditions. None of these schemes worked very well for banks. However, at that time, it was a pure market share game. This time around, SBI, majority owned by the government, is also gambling on economic growth.
Tamal Bandyopadhyay keeps a close eye on all things banking from his perch as a deputy managing editor of Mint. Comments are welcome at firstname.lastname@example.org