Page 49 - Banking Finance September 2023

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in an arbitrary manner and tenors are extended without What’s the interest rate reset?
informing the borrowers. Further, borrowers are not
When a customer takes a home loan, the interest rate reset
informed about the foreclosure charges. The RBI has also
clause in the loan agreement allows the lender to review
observed that unduly long elongation of tenor has
the interest rate after a certain period, as per the
camouflaged stress in banks.
occurrence of a scheduled reset date of the loan. The reset
rate is the new interest rate that a borrower must pay
Theoretically, the borrower can refinance the floating rate
effective from the scheduled reset date. EMI of a floating
loan by going to another bank, but in practice, this does not
rate loan changes with periodical changes in reset interest
work well. Floating rate loans of different banks with internal
rates. These rates and the calculation are not uniform for
benchmarks are not identical even if spreads are identical
all the banks as the cost of funds differs from banks.
at loan origination and in future, given that different banks
change or reset internal benchmarks differently. The
What banks say
borrower in such a situation is more often left with no
According to banks, when an external benchmark rate –
choice, but to remain captive to the original bank and pay
banks use Repo rate now – is adopted for fixing the lending
higher charges on existing loans rather than refinance.
rate, the reset period should be linked to the tenor of the
underlying external benchmark. While longer reset periods
What are personal loans?
increase transmission lags, shorter resets increase interest
As per the RBI definition, personal loans are the loans given rate risk for banks.
to individuals and consist of consumer credit, education
loan, loans given for the creation or enhancement of Banks have indicated that retail customers would resist a
immovable assets (such as housing loans), and loans given shorter (quarterly) reset, particularly in a rising interest rate
for investment in financial assets (shares and debentures). cycle, because of the increase in equated monthly
The total outstanding under the personal loan category was instalments (EMIs) or longer repayment period with uniform
Rs 42.60 lakh crore as of June 2023, which is almost 30 per EMIs. Conversely, in a falling interest rate regime, borrowers
cent of the non-food bank credit. prefer shorter resets. (Source: The Indian Express)

RBI in tight spot as interest rate differential with US narrows
The Federal Reserve's latest move to raise its policy rate, marking the 11th increase in 12 meetings, has sparked
widespread discussion in economic circles. The overnight interest rate at 5.25%-5.50% now stands at its highest
level in 22 years, prompting the European Central Bank to follow suit with its 9th consecutive rate hike, reaching
levels not seen since 2001. While these actions were somewhat anticipated, they have inadvertently created a
challenging situation for India's central bank.
India finds itself at a critical point as its interest rate differential with the US has notably narrowed (see Figures 1 &
2 wherein government bond yields have been used as proxies for interest rates). This tight spot has left the Reserve
Bank of India (RBI) facing a tough decision - whether to align with global peers and raise its repo rate or opt for a
differing path.
On one hand, following the global trend of raising interest rates might help control inflation and fortify the Indian
rupee. However, this move carries various implications for the country's economic growth. Despite uncertainties in
the global economic outlook, India has sustained strong economic momentum since the COVID-19 pandemic, achieving
a robust growth rate of 7.2% in FY 2022-23. Elevating interest rates would inevitably heighten credit costs for
businesses and consumers, thus potentially dampening India's growth trajectory.
However, choosing not to raise interest rates in order to support growth may have implications for India’s capital
account. As yield spreads between Indian and US government bonds shrink, foreign investors may find the risk-reward
ratio unfavourable, leading to capital outflows. Such fund outflows could strain India's economy and its currency.

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