RBI has stirred up quite a brew with its suggestions to the banks on the interest rates on loan products. The banks are quite perplexed as to what to do since it will directly affect their earnings and takeaway the room for manoeuvring.
Consider this: A 5-basis point (bps) reduction on the net interest margins (NIMs) earned by banks could impact their pre-tax profit for the year 2019-20 by 4%, according to CLSA.
Under these circumstances, Financial Express quotes experts as saying that borrowers of home loans may end up paying up the entire interest portion on their loans by the first year itself. Even otherwise the loan repayment EMIs are structured in way that the interest component is high during the initial periods and the principal very low. The ratio gradually changes and the last few EMIs would be all principal only. With this floating rate scenario however, the banks may not want to take any risks with further reduction in the rates by RBI and would look to recover its interest as early as possible. In a 20-year home loan for example, you may have paid off the complete interest in the first 12 months and the remaining 19 years only the principal is being recovered by the bank.
Banks may keep the option of offering fixed rate loans as well. Besides home loans, lending products to SMEs and micro business units are also covered by the RBI as far as linking with the floating rate is concerned. Interestingly, the discussions are all revolving around only one scenario where the interest rates may keep falling going ahead. What will happen if the interest rates were to go up?
The other dilemma in front of the banks is to handle the rates of interest on term deposits. A majority of fixed deposits are utilized by senior citizens in order to build a steady income for themselves. They will shy away from an uncertain floating rate product where the interest earnings could fluctuate.
It is understood that the recent direction by the RBI to link loans to market rates does not cover personal loans, vehicle loans and credit cards.
The banks may be spared any changes in the way they have been lending to the corporate sector, where the MCLR mechanism is followed.