All about change in interest rates

‘Banks can reset interest rate on loans without informing borrowers’
All about change in interest rates
Representational Pic

A recent judgment passed by the National Consumer Disputes Redressal Commission (NCDRC), New Delhi, in a dispute between ICICI Bank and its customer is remarkable. The NCDRC observed that ‘the bank was well within its rights to increase or decrease the rate of interest’ as per the floating rate of interest provided for in the loan agreement executed between the bank and the complainant and any additional or further consent from the complainant was not required, the same having been agreed to in the loan agreement itself. 

According to the history sheet of the case, the aggrieved customer in 20019 approached the State Commission, New Delhi against ICICI Bank. The customer alleged that the bank increased the interest rate of a home loan and expanded the tenure of EMIs without informing him. The State Commission decided against ICICI Bank with directions to pay Rs. 1.62 lakh along with interest in addition to an aggregate amount of Rs. 1 lakh towards compensation and costs. The bank filed an appeal before the NCDRC against the State Consumer court order.

“There is nothing on record to show that either the bank had fixed the rates of interest in any erroneous way, contrary to the principles and the guidelines applicable or had differentiated between similar situate borrowers in this respect,” the order further added.

As far as banker-customer relationship is concerned, the judgment puts the banks in the driver’s seat and innumerable complaints against the banks by their borrowers in the above context will stand dumped in dustbins.

Frequent fluctuations in interest rates have been annoying borrowers as banks have been resetting these rates unilaterally. Despite resentment, the borrowers are left with no choice but to pay the extra bucks during the repayment of their loans. However, it breeds dissatisfaction among the borrowers and they don’t treat their banks customer-friendly.

Before coming to the exact issue pertaining to the changing rate of interest and its impact on the banker-customer relationship, let’s have a snapshot of the banking industry. We find that the last three decades have seen a remarkable increase in size, spread and scope of activities of the banks. Their business profile has transformed dramatically as their operations have gone beyond traditional activities. Today the banks offer facilities like merchant banking, mutual funds and new financial services & products.

But do banks continue to be customer friendly? This is the most important question today being asked whenever the role and performance of banks is discussed formally or informally. Let me share an instance with you. Some time back I attended a brainstorming interactive session on branding in which some top rated branding experts highlighted its importance vis-à-vis image building of an organisation like banks. The deliberations during the session emphasised on the need to offer high quality customer service which alone can help the banks to build their brand image. The session concluded with a serious note that we rarely find a customer-friendly bank today despite the fact that integration of technology has revolutionised banking services and digital banking has become a new world order in the banking industry.

Now coming to the core issue of rising interest rates. The rate of interest factor has hurt the interests of borrowers. It is very common to find banks raising interest rates periodically; many a time, they don’t even bother to inform their borrowers about the rate increase. Banks just increase the amount of equated monthly instalment (EMI) payable or even raise the number of installments payable by a borrower.

Notably, for quite some time now, since May 2022, interest rates on loans are continuously going up to fall in line with the Reserve Bank of India’s (RBI’s) benchmark rates. On December 7, the Reserve Bank of India increased the policy rate by 35 basis points to 6.25 per cent, fifth in series since May 2022, which has pushed the interest rates on loan such as home loans, car loans, mortgage loans etc. up.

The benchmark rate (repo rate) has gone up 225 basis points since May when it was increased by 40 bps. A 50 bps hike was done each in June, August and September.

The movement in the repo rate decides the cost of loans (in terms of rate of interest) for the borrowers. As the repo rate stand hiked by 225bps since May 2022 and already crossed the pre-pandemic level, popular retail loans like housing loans, car loans, personal consumption loans, business loans etc. are now more expensive. The EMIs of the existing borrowers will go up and they will have to shell out more to fall in line with the increased benchmark rate of interest. The impact will be equally on the new borrowers as the cost of loan will shoot up.

It’s worth mentioning that all floating loans in the retail segment sanctioned by banks after October 1, 2019 are linked to an external benchmark. In most cases the external benchmark is the repo rate. This means that the latest hike in repo rate will be fully passed on to the borrowers and banks must be busy in calculating the percentage of interest to be increased.

The most annoying part of this rate hike for them is that they feel ‘cheated’ by their banks as the transmission of  extra percentage of interest is loaded in the EMIs without informing them. Now as per the above mentioned National Consumer Disputes Redressal Commission (NCDRC) ruling, it’s not obligatory for banks to inform borrowers about any change in the rate of interest.

Meanwhile, usually there are two options to charge interest on loans - fixed rate and floating rate option. In the fixed rate option, the interest rate is fixed for the entire period of the loan. However, this fixed rate option too can change. Notably, it is a practice in banks to include a reset clause in the loan agreement in which the borrower authorizes the bank to reset the fixed rate whenever deemed fit by the bank.

Mostly, the borrowers are unaware of this reset clause of the fixed rate option. When the bank invokes this clause, the borrowers call it cheating by the bank, which actually it is not. We have seen most of the borrowers have a habit not to go through the loan agreement documents before availing the facility. They only come to know about terms and conditions when the banks enforce them.

In the case of a floating rate option, the interest rate is not fixed. It is linked to the benchmark rate. If this benchmark goes up, interest rate on the loans also go up and subsequently EMIs also go up. However, if the rate goes down, the interest rate and monthly repayment on the loan will also go down. The bank fixes a spread between benchmark rate and floating rate while sanctioning a loan. The spread remains constant during the tenure of the loan. However, the spread can be changed with mutual consent of the borrower and the bank.

Now, what is the way forward in the rising interest rate scenario? While opting for loans, it is always necessary to look beyond the initial years and calculate the potential impact that EMI payments will have on your future financial life. It is just a matter of good financial planning.

Ensure total EMI of your loans remains below 40 percent of your take home salary. Examples galore which suggest that anything outside this range puts a borrower into a debt trap. Don’t get lured to small/affordable EMIs. Always remember that your monthly budget and cash flow position is always changeable under the circumstances of repaying a bank loan. Check your net income (inflow) and expenditure (outflow) and the difference between the two will give you the quantum of your cash reserve. This cash reserve figure is the actual empowerment you possess to decide the amount of loan you can obtain and repay without any default.

Precisely, the power of a bank loan has two sides. It can either bring prosperity to you or leave you in a debt trap. Choice is yours.

 

(The views are of the author & not the institution he works for)

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