PNB, Nirav Modi, and a floating home loan that promises to really float

The PNB fraud has left many of us feeling cheated although no money has gone out of our pockets directly. We feel cheated because the rich and the well-connected once again appear to have managed to get away after stealing a large amount of money. The pictures of smug high lifers seem to be mocking those who play by the rules.

We feel cheated because we are made to feel like criminals when we intersect with the financial sector—each of us, every few years, has to redo our KYC details. The linking of Aadhaar to various services has now reached a level where a corporate chemist chain is sending texts to customers to link Aadhaar to the account. When we seek a loan, the due diligence process is exhausting; the contracts are not really two people agreeing, it is the weaker party (us) just signing what the stronger party (bank) shoves across the table. Miss one EMI or get behind your credit card payment and the hounding begins relentlessly. A friend’s sister is a senior bank manager in a state-run bank in a small town in middle India. A part of her territory is also the nearby rural clusters and some of her work is loan recovery. As details of the Nirav Modi theft emerged, her sense of disbelief grew. She said that when sometimes people defaulted on loans, she has actually threatened to walk off with a cow or a goat as collateral to make good the bank’s loss. For the poor people, who will surely be even less able to pay their debt with their asset gone, the loss would be mind numbing. But the rich get away with it because of political patronage, collusion and greed. Fraud of this kind corrodes the overall value system of a nation when people feel justified in cheating and not paying taxes.

We feel cheated because the banks are allowed by a regulator to sell products that are unfair. One such product has been a floating home loan. A ‘floater’, as opposed to a fixed-rate loan, is supposed to be a fairer product as it is market linked. A floater is pegged to a benchmark that goes up and down as the interest rate cycle in the country moves. When rates go up, your floater rate rises and when they go down, you pay less. That is theory. In real life, interest rates on retail loans go up very fast but banks don’t allow them to float down. That is because banks control their own benchmarks. The banking regulator has tried several times to get the banks to behave better. The last seven years have seen three attempts by the Reserve Bank of India (RBI) to change the way the benchmark is calculated, but none of them have worked because banks still control the way the calculations are done.

It is in this context that when a bank comes out with a product that looks fair, all red flags start to wave in our office. We do the math, look at the fine print and think of ways in which the product will cheat the consumer. Nine times out of 10 we find the monkey in the product. When Citi Bank announced its third-party benchmark home loan product, we went through a similar exercise. See this story by my colleague Vivina Viswanathan on how this happens. We found that the product is benchmarked to the three-month Treasury bill rate, which is not controlled by any one bank, and it does look as if India has a true floater. This is the second attempt by a bank to use a third-party benchmark. Around 2004, ING Vyasa Bank had launched India’s first Mumbai Interbank Offered Rate (Mibor) linked home loan. You can read about it here. Several other banks too tried the product but were unable to compete with banks that used their own benchmarks and the product was discontinued. But can’t third-party rates be gamed? Of course, they can. Where there is a banker, there is potential for gaming. The big Libor scandal showed how a group of banks manipulated the London Interbank Offered Rate (Libor) to make profits starting 2003. Over $9 billion have been paid by these banks in fines for this manipulation of a benchmark, on which the world had pegged its trades, rates and businesses. Read this story for more about the Libor scam: Understanding the Libor Scandal

Experts say that the T-bill rate, on which the Citi product is pegged, will be difficult to manipulate by a bank. It remains to be seen if other banks will move to a third-party rate, what this benchmark will be, and whether they can collude and fix that as well. Ideally, there should be one third-party rate that all banks peg their rates to and which cannot be manipulated. They can offer higher or lower spreads—of the difference between the benchmark rate and the offered rate to the borrower.

Why has the RBI not forced banks to use a benchmark they cannot control? That’s a larger question that the finance minister needs to ask: who is responsible when a regulator is found lax? The Nirav Modi story is telling retail banking consumers that the rules are only meant for us, the retail consumers. The rich and well connected get a free pass. That the banks are allowed to cheat retail consumers at will is not a good message in a pre-election year for sure.

Monika Halan writes on household finance, policy and regulation. She is consulting editor Mint. She can be reached at monika.h@livemint.com.