Mumbai: In a move that will cheer millions of small borrowers, banks have agreed to abolish penalties for prepayment of home loans taken on floating rates of interest. They will also stop penalizing savers who fail to maintain a minimum balance in their bank savings accounts.

The decisions were taken at a meeting between the Reserve Bank of India (RBI) and the bankers’ lobby Indian Banks’ Association (IBA) on Friday, hours after the central bank signalled an end to the cycle of rising interest rates that started in March 2010, according to bankers who participated in the meeting and spoke on condition of anonymity.

File photo of a couple speaking to an HDFC Bank loan officer about a home loan at a branch in eastern Mumbai (Bloomberg)

In step with RBI rate increases, banks have been raising home loan interest rates, which raised the equated monthly instalments of borrowers.

Harsh Roongta, chief executive of, an online provider of information relating to price and features of loans, insurance and investments, said the agreement by banks removes an impediment for borrowers wanting to change their mortgage lender.

“Banks overcharge their existing customers and the prepayment penalty prevents them from moving to cheaper competitors," he said. “This will facilitate movement of customers and remove a major financial hurdle. Lenders will now either have to drop interest rates for existing customers or risk losing them."

The decision to abolish the prepayment penalties followed two meetings on Friday attended by RBI deputy governor K.C. Chakrabarty, IBA chairman M.D. Mallya and top bankers including ICICI Bank Ltd managing director and chief executive officer Chanda Kochhar and HDFC Bank Ltd managing director Aditya Puri.

The top three home-loan providers—Housing Development and Finance Corp. Ltd (HDFC), ICICI Bank and State Bank of India (SBI)—have already announced discontinuation of penalties for prepayment.

HDFC waived the prepayment penalty on floating rate loans after a notification by the mortgage lending regulator, the National Housing Bank.

ICICI Bank and SBI announced their decisions last month. SBI has abolished penalties on both fixed as well as floating rate home loans. ICICI continues to charge 2% of the loan amount outstanding as a penalty if borrowers prepay a fixed rate loan.

Abolishing prepayment penalties was one of the 10 action points adopted by banks at the annual conference of banking ombudsmen in Mumbai in early September to improve customer service. But banks backtracked from the agreement weeks later, arguing that the move could lead to supply-demand mismatches in liquidity.

The abolishment of prepayment penalties was first proposed by a committee headed by former Securities and Exchange Board of India (Sebi) chairman M. Damodaran in June 2010; the committee looked into banking services rendered to retail and small customers, including pensioners.

Other recommendations of the committee included creation of a toll-free common bank call number for redressal of customer complaints and offering of no-frills savings account without a stipulated minimum balance amount.

The minimum balance that has to be maintained in bank accounts ranges between 1,000 and 25,000. Banks also offer no-frill accounts that do not require a minimum balance.

Damodaran said the committee he headed wanted to ensure that bank customers are free to switch to other banks.

“In any industry the customer has a right to choose a service provider without getting locked in," he said in an interview. “Customers should have a choice. The committee held wide-ranging consultations with bankers and other people, and as a chairman, I am happy that some of these have been accepted."

IBA chairman Mallya confirmed that banks met RBI to discuss the Damodaran committee recommendations on Friday.

“Prepayment penalty is not there in 11 of the banks and it is left to the rest what view they will take on this," said Mallya, who is also chairman and managing director at Bank of Baroda. “Our bank has waived the penalty."

K. Ramakrishnan, chief executive officer of IBA, said the banking lobby group will follow up with banks and monitor the implementation of these recommendations.

“The rest of the recommendations will be implemented in a phased manner after coming to a consensus after discussing the issue with banks and RBI," Ramakrishnan said.