The Reserve Bank of India (RBI) on Thursday announced plans to establish a transparent framework for the resetting of interest rates on floating-rate loans. While making the bi-monthly monetary policy announcement, RBI Governor Shaktikanta Das revealed that the central bank will soon introduce a framework allowing borrowers to transition from floating interest rates to fixed interest rates.

This move aims to provide relief to individuals with home, auto, and other loans who have been grappling with the burden of high-interest rates. The proposed framework will primarily focus on enhancing communication with borrowers regarding any changes in loan schedules and adjustments to equated monthly instalments (EMIs).

According to Abhay Bhutada, MD at Poonawalla Fincorp, RBI’s decision will bring more transparency for reset of interest rates on floating interest loans, which will further reinforce consumer protection.

The current framework

The RBI introduced the external benchmarking system for home loans on October 1, 2019. Under this, all floating rate-based loans were required to be linked to an external benchmark. Initially, when the external benchmark system was introduced, the RBI allowed banks to reset the EMI once three months.

Currently, borrowers can switch between floating and fixed interest rates and vice versa. However, they may have to pay a conversion fee which can be anywhere between 0.50 percent to 2 percent of the home loan amount.

The proposal

In light of supervisory reviews conducted by the RBI and input received from the public, instances of lenders prolonging the tenor of floating-rate loans without proper consent and communication have been identified. To address this concern, the RBI intends to establish a comprehensive conduct framework that all regulated entities must adhere to. This framework aims to rectify the challenges faced by borrowers.

Governor Das said that the envisioned framework will require lenders to maintain clear communication channels with borrowers when it comes to resetting loan tenors and EMIs. It will also mandate the provision of options for switching to fixed-rate loans or prematurely closing loans. Additionally, the framework will emphasize transparent disclosure of associated charges and ensure that crucial information is effectively communicated to borrowers.

Das said that the framework will assess various options available to borrowers, including the possibility of switching to fixed-rate loans or opting for loan foreclosure. Additionally, the RBI will scrutinize the disclosure of charges related to these options and ensure that essential information is adequately conveyed to borrowers.

Understanding floating and fixed loan rates

The floating interest rate is volatile and keeps on changing as per the market scenario. This type of interest rate depends on the base rate offered by several lenders, so whenever the base rate changes, the interest rate gets automatically revised. This can be seen whenever RBI makes changes to its repo rate and the same is passed on to the borrowers.

On the other hand, people who opt for fixed home loan interest rates have to repay the home loan in fixed and equal instalments as per the loan tenure. The advantage of a fixed interest rate is that it would not change even if there are fluctuations or changes in the Indian financial market conditions or trends.

Here's a comparison between fixed and floating home loan interest rates:

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First Published:Aug 10, 2023 10:56 AM IST