Mumbai: K.C. Chakrabarty, Reserve Bank of India’s (RBI) deputy governor overseeing banking supervision, rural credit and customer service, said in an interview that banks selling teaser loans—that offer cheaper rates in the initial years—and customers buying them must understand the associated risk. When banks are “teasing", they must “tease" both existing and new customers, he said, otherwise it’s a discriminatory practice.

“Some of us have a strong apprehension that the motivation for introducing teaser loan was not product innovation, but to deprive existing floating rate home loan borrowers the full benefit of declining interest rates based on market realities," he said.

Edited excerpts:

Financial inclusion has been at the top of RBI’s agenda for many years, but 60% of India’s population is still out of the banking fold. What is the most critical challenge before the regulator?

The key challenge is the business strategy to be adopted by banks and an appropriate delivery model. Effective technology-based delivery model is not there even today. Also, banks don’t have a definite business strategy.

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So you are not satisfied with the way banks are progressing with financial inclusion programmes?

They are making efforts. But banks have to develop a business strategy and understand what is an appropriate delivery model, without which it will be difficult for them to scale up. We have introduced business correspondent (BC) model. But banks are saying they don’t have trained BCs and are not getting enough BCs. Unless banks succeed in creating a suitable delivery model, it will not work. Banks also require support from all stakeholders, including policymakers and government agencies, to make financial inclusion a reality.

To what extent has the ongoing crisis weakened the ability of microfinance institutions (MFIs) to serve the poor?

KC Chakrabarty, deputy governor, Reserve Bank of India. Abhijit Bhatlekar/Mint

RBI is set to come with new regulations to govern the sector based on the Malegam panel recommendations, of which you are a member. Will the norms solve the crisis?

If the recommendations are implemented properly, they are supposed to solve the problems. All MFIs having a net worth of Rs15 crore will be designated as NBFC (non-banking financial company)-MFIs and will have to get registered with RBI. Still, there may be others who will be left out. How do we regulate them is a different issue. The committee has recommended the broad principles for them in the report. It may take some time, but the report will definitely have to be implemented if things are to improve.

MFIs argue that it’s difficult to cap the margins at 10-12% when the price of the money they raise from banks keeps fluctuating.

If your funding cost is higher, you have to improve your operating efficiency. The committee is not saying that they must have 12% margin in all cases; it’s only a cap. One can work with even a 6% margin. The committee has studied and found that majority of the MFIs are able to work within the range indicated in the report. If one or two players say their cost is higher and cannot accept this, they have to increase their efficiency to bring down cost. We cannot create a system based on the premise that the least efficient institutions should be the benchmark.

Are you hinting that MFIs should enhance efficiency and reduce operational cost through consolidation?

Those who want to function within our regulatory framework will come for registration with RBI. Those who cannot will not come. Our understanding is that today majority of the MFIs which work efficiently are able to function within this framework. If someone can demonstrate that majority of the players are not able to function within this framework, we are ready to examine it. We should be clear that we are not rigid and dogmatic about it.

Once the RBI regulations come into play, will Andhra Pradesh regulation cease to exist?

You must understand that the state is sovereign. The state and the RBI are two different things. What we have said is that certain areas come under the regulation of the RBI and the state need not enter there. To be very frank, in many areas, even the Andhra Pradesh government has not entered into the domain of RBI. The state has a big role in creating a conducive ecosystem for microfinance. For example, the issue of coercive recovery. If someone comes and complains that somebody has threatened him, we will write to the state government, which will take action as per law. RBI has no machinery to do that.

So both the Andhra Pradesh law and RBI regulations can coexist?

Our recommendations are very clear. We believe all concerns (in Andhra Pradesh Microfinance Act) have been addressed in the report. We believe that after this there is no need for the AP type Act. But still, if the state governments feel differently, they are sovereign, and we cannot interfere in their area.

Raghuram Rajan has made a case for smaller banks, saying such banks can understand and cater to the needs of rural customers. Is there any scope for MFIs to become banks?

Our discussion paper has given pros and cons of their becoming banks. As and when the guidelines come out, we will get the answer.

Banks have almost stopped lending to MFIs following the crisis, saying they are waiting for the implementation of the Malegam proposals, despite RBI asking banks to resume lending.

Have the MFIs paid back the money? When you are in a crisis, you have to scale down your business a little bit. If you are able to pay back the money, you can ask the banks to be less harsh. Banks will not lend to MFIs if they feel that they will not get back their money. The onus is on the MFIs to give that comfort and confidence to banks that they will be in a position to give back the money. Then only banks will lend. Can we ask banks to continue to lend even if they are not comfortable about repayment? Anyhow, the restructuring package is supposed to sort out many problems.

After the Citibank fraud case, there is a view that there is need to further beef up the supervision mechanism and scrutiny of banks’ operations more closely.

Yes. I agree. But the RBI does not do risk management for banks. It is in banks’ interest and it is the banks which have to do their own risk management. We tell the banks that they must continuously look at their systems and processes of risk management. But that does not mean that there will be no failure. Some accidents will always happen and all of us have to learn from such incidents.

Under investment advisory channels, banks offer different investment products to customers that come under various regulators. How can the regulator ensure the customer is receiving investment advice from a qualified adviser?

Customers who avail of such products should understand them. Banks which are doing such business should create some basic guidelines on how should they do the business and select people to act as advisers. The cardinal principle is that if you are doing investment advisory, you must understand what is the risk to the customer in a particular product and service, and make sure that the customer also understands it.

If it involves various regulatory turfs, we have to address them collectively in a coordinated manner. But that issue is not paramount as of today. We have not taken any particular stand on this issue as of now. People who sell such products and services must understand the risk-return framework of those products and services, and also explain the same to customers.

Some banks are still continuing with so-called teaser loan products even after opposition from RBI.

We have not banned the product. Teaser loan is a globally accepted product. But it is a riskier product than the normal floating rate housing loans. Banks which are selling that product, and customers who buy that, must understand the associated risk. Our regulatory stance is very clear: it is a riskier product for the customer as well as the banks. That is why we have imposed some extra provisions for that. Whether that provisioning is too high or too low is a matter of judgement.

But banks still continue to favour new customers with lower rates; and when rates fall, they do not pass it on to the old customers.

That’s another issue and you should appreciate when you are teasing, you must tease both the existing and the new customer. Otherwise, it is discrimination between the new and existing customers.

This aspect of teaser loan and associated systemic risks, in fact, has avoided public scrutiny. Some of us have a strong apprehension that the motivation for introducing teaser loan was not product innovation, but to deprive existing floating rate home loan borrowers the full benefit of declining interest rates based on market realities.

Banks have a huge burden of infrastructure funding. The rising asset-liability mismatch lessens their ability to do this.

Nowhere in the world such huge requirements of infrastructure is funded by the banks alone. It requires different types of specialized institutions, which mobilize long-term resources such as pension funds and insurance funds. But that doesn’t mean that banks are avoiding infrastructure funding. Whatever is our requirement in the short term, the banking system will be able to meet that. But, in the longer term, you cannot depend only on banks to create world-class infrastructure. Our problem in infrastructure development is not only of finance. There are many other issues associated with project implementation.

How can banks tackle the issue of rising asset-liability mismatches?

Those who cannot manage their asset-liability mismatch should not be in the business of banking. If banks feel they cannot manage the risk, they should take less risk. If this is the reason that could create problem for banks to fund infrastructure, how have they been funding the sector so far? Their funding to the sector has gone up from 5% to 15%. We, however, don’t see any reason why banks cannot address these issues within our framework.

A section of banks feel deregulation of savings deposits may not be good for the banking system.

We had mandated interest rates, both on asset and liability sides, some 25 years ago. Now, on the assets side, we have deregulated interest rates on all items; but on the liability side, we have deregulated all rates except one. Why shouldn’t we deregulate the remaining one which covers around 20% of the banks’ liabilities? You cannot say that deregulation is not good only for one product and service. At the same time, we need not do anything in a hurry.

RBI has expressed concern over the abnormal credit to deposit ratio of certain banks and said it will engage with banks, if necessary, to address the issue.

Things are improving. Liquidity in the system is improving. We did not want things to deteriorate. That is why we cautioned the banks. We hope that they will rectify the situation. We have to give them some time.

Rising interest rates have started hurting industries, particularly small and medium units, and the common man. Is it posing a threat to overall growth?

Why only manufacturing? Prices of rice and vegetables have also gone up. What RBI is advocating is that we must have low inflation. Whatever measures needed to control the inflation, we must take.

People forget that the saver is the greatest beneficiary of rising interest rates. When rates go up, the saver gets the benefit and the borrower’s cost of funding goes up. When the interest rates come down, the borrower gets an incentive, but savers suffer. The RBI maintains that balance. That balance is based on the inflation rate. If inflation rate rises, the saver has to be given a rate higher than inflation and the borrower has to borrow money at a rate higher than inflation. Also, interest cost is not the only factor in raising cost of manufacturing. Today, on an average, interest cost is only 6-7% of the total cost of manufacturing.