Prepayment Charges on Floating Rate Loans may soon be History

RBI unveiled its path breaking second quarter review of monetary policy and announced far reaching changes that affect the common consumer positively.

The big bang announcement included the deregulation of the savings account interest rate. Each bank is required to have at least one category of savings account where deposits are less than Rs. 1 lakh. Each bank can have more categories above that amount for which it can fix different rates of interest for each such category it chooses to create. Given the current market scenario it is unlikely that banks will start a rate war for savings account. So for lay consumers who keep less than Rs. 1 lakh in their savings account it is unlikely to make much of a difference. The market will evolve but we may soon see higher transaction based charges come in for all consumers. It is in the Rs. 1 lakh plus category that we are likely to see a lot of action with more and more new products coming in to cater to this class of consumers. If there is a rate war that leads to increase in interest rates on savings accounts, it will lead to increase in lending rates as well.

In an innocuous sounding announcement, RBI also announced that it will implement some of the recommendations of the Damodaran committee report as well as the 10 action points identified in the Banking Ombudsmen conference. One of the 10 action points was abolition of pre-payment penalty on floating rate loans. Whilst no time frame for implementation has been announced, it should follow soon. This will remove one big irritant for loan consumers seeking to transfer their loans from one lender to another and also ensure that (at least for alert consumers) banks cannot overcharge existing consumers as compared to their new customers.

RBI has also noted the complaints received regarding the non-transparency of pricing even under the base rate regime and has set up a group to make recommendations on how transparent and nondiscriminatory pricing for both old and new consumers can be achieved.

As expected the Repo rate and Reverse Repo rates were raised by 0.25% but with clear indications that there is unlikely to be any further increase in the next review. This increase by itself may not lead to any immediate increase in lending/ fixed deposit rates unless there is a rate war over savings bank accounts.

All in all a very clear and transparent policy that is likely to lead to significant changes in the way retail banking is done.