EMIs: Reserve Bank plans framework to reset interest on floating rate loans

EMIs: Reserve Bank plans framework to reset interest on floating rate loans

Subject: Economy

Section: Monetary Policy

In News: Reserve Bank of India has released a key proposal with the goal of improving both the flexibility and transparency of rates of interest on variable-rate loans.

Key Points:

• There have been several instances of unreasonable elongation of tenor of floating rate loans by lenders without proper consent and communication to the borrowers. This has led RBI to bring a new framework to reset interest rate or tenor on floating rate loans.
• The framework will require Regulated Entities to
  • (i) clearly communicate with borrowers for resetting the tenor and/or EMI;
  • (ii) provide options for switching to fixed-rate loans or foreclosure of loans;
  • (iii) disclose various charges incidental to the exercise of the options; and
  • (iv) ensure proper communication of key information to borrowers.
• These measures are aimed at further strengthening consumer protection.
• The framework aims to achieve following:
  • To give borrowers with variable rates of interest loans with a more predictable process for resetting interest rates.
  • It would improve openness about interest rate computations and allow borrowers to transition from fluctuating to fixed rates, providing stability and security against future volatility.
• The transparency of EMI on floating rate loans can be related to three areas: the benchmark rate, the spread over the benchmark, and the frequency with which the interest rate is reset.

What are floating-rate loans?

• • Banks can offer floating-rate loans based on external benchmarks, such as the repo rate or the 10-year government security yield.
  • These rates are already transparent because they are external to banks. However, in most cases, banks offer floating rate loans based on the internal benchmarks such as the Marginal Cost of Funds based Lending Rates (MCLR).
  • While the RBI has established an objective framework for calculating MCLR for individual banks, there is room for subjectivity in determining these rates.