Is your home loan EMI rising?
Base rate system The base rate was introduced by the RBI to replace the opaque and ineffective Benchmark Prime Lending Rate (BPLR). Under the previous system, banks were expected to lend above their BPLR, which was based on their true cost of funds. However, over time, competition forced the banks to give loans at rates lower than the BPLR.
Mostly, they offered subsidised loans to corporate customers while charging higher interest rates from retail customers. Also, they stopped adjusting the BPLR when the interest rates went down, so it lost its relevance as a rate reflecting the cost of funds for banks. To bring in transparency, the RBI recommended the base rate, the minimum rate at which banks could lend. Banks could calculate their own base rates using any method (the RBI provided an illustrative formula) and had to list it on their Websites.
Though this process is meant to be more transparent, it isn’t as clear as it should be to the average customer. This is because the RBI has allowed banks to add charges, such as risk premium (depending on the risk assigned to a customer) and product premium (the cost of administering a product), which form the spread, to the base rate while calculating the final rate.
So, while the base rate takes into account factors that are common to all borrowers, the actual lending rate also includes charges which are specific to the borrower, such as loan eligibility, credit worthiness and risk profile. Is the increase in spread justified? The RBI’s guidelines state that the amount of the spread may differ from one lender to another, but it should be ‘usually constant’ over the life of the loan. Some banks follow this guideline. Says Jairam Sridharan, head, consumer lending and payments, Axis Bank: “In our case, once a loan is sanctioned or disbursed, the discount/mark-up remains constant for the tenure of the loan.”
This is echoed by an ING Vysya spokesperson, who says, “As a bank policy, the base rate changes from time to time, but the spread for a specific loan is not changed.” However, not all banks follow the same principle. We approached 11 banks and the RBI to seek clarity on when the spread can and should be changed instead of just hiking the base rate. Only three banks, ING Vysya, Axis and Dhanlaxmi, chose to respond. Several other top banks, including ICICI Bank, HDFC Bank, YES Bank, Kotak Mahindra Bank and Union Bank of India, declined to comment despite several reminders. Adhil Shetty, CEO of Bank Bazaar, believes that increasing the overall interest rate by hiking the spread, instead of the base rate, is an unfair practice.
Mumbai-based Srinivasu Subramani received a rude shock in April this year, when his bank informed him that the interest rate on his home loans had been hiked to 11.5% from 9.25%. This was the second interest rate revision in six months on his loan of Rs 99.9 lakh. Subramani had taken a loan from Deutsche Bank at 8% in September 2010. The interest rate was arrived at by adding 1.25% margin to the bank’s base rate, which was 6.75%.
“In January 2011, the bank hiked the spread on my loan by 25 basis points. I took it up with the bank and wrote e-mails to the RBI, after which the bank reversed the spread, citing ‘service gesture’ as the reason,” says Subramani. However, in April, the bank raised the base rate by 300 basis points to 9.75%. Subramani was prepared for this as the RBI had frequently increased the repo rate (the rate at which it lends to banks) since March 2010 and banks were passing on this hike to customers.
This meant that the interest rate on Subramani’s loan would be 11% after adding the margin of 1.25%. Instead, he was confounded that the bank had increased the interest rate to 11.5%. When Subramani approached the bank, he discovered that it had once again hiked the spread over his loan, this time by 50 basis points. “This was the second time that Deutsche Bank had increased the spread. I had to again go through the whole rigmarole of solving the issue, which the bank finally did after a long exchange,” says Subramani.
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