RBI has issued comprehensive lending guidelines from time to time with the intention of creating clarity, choice, and fairness in lending practices. These circulars and Master Directions pertain to Scheduled Commercial Banks (SCBs), Non-Banking Financial Companies (NBFCs) and Housing Finance Companies (HFCs). EMI loans form the cornerstone of these rules which aim to inform, empower and provide viable loan repayment solutions throughout borrowers’ loan duration. Recently, RBI has issued guideline to allow flexibility in interest rate offerings for borrowers paying EMIs under floating rate:
RBI Notification dated 18/08/2023: Guidelines on Switching/Reset of Floating Interest Rate Loan EMIs
Interest Rate Flexibility
As per the current guidelines from the RBI, regulated entities (REs) have the flexibility to provide advances across all categories using either fixed or floating interest rates.
Assessing Repayment Capacity for Floating Rate Personal Loans
REs are required to carefully consider borrowers’ repayment capacity when providing personal loans with equal monthly installments (EMIs) that feature floating rate financing, so as to provide adequate provisions in case an extended loan tenor or increase in EMIs becomes necessary as a result of fluctuations in external benchmark rates over the duration of a loan agreement.
Addressing Consumer Needs and Concerns
Due to rising interest rates, consumer complaints regarding extended loan tenures and unexpected EMI increases without proper communication or borrower’s consent have increased. REs are advised to create a comprehensive policy framework which adheres to these stipulations:
1. Clear Communication of Benchmark Rate Impact
REs must effectively inform their borrowers of the potential ramifications of changes in benchmark interest rates at the point of loan approval, such as their impact on EMI amounts and loan tenure. Any adjustments due to benchmark rate changes must be communicated quickly through appropriate channels.
2. Option for Fixed Rate Conversion with Every Reset
REs should provide their borrowers with an option to switch from variable interest rate loans to fixed-rate loans upon every interest rate reset, in accordance with their board-approved policy and on a periodic basis during loan tenure.
3. Borrower Empowerment
Lenders should provide their borrowers with choices, such as increased EMIs or longer tenures or combinations thereof, along with partial or full prepayment at any point during their loan’s term without incurring charges for prepayment or changes in interest structure that violate established guidelines.
4. Transparent Disclosure of Charges
Transition from floating to fixed interest rates must be disclosed in detail in a loan sanction letter, along with any service charges or administrative costs that come with this option. Any subsequent revisions to these fees should also be communicated openly to borrowers.
5. Term Extension and Borrower Statements
REs are required to ensure that extending the term of a floating rate loan does not lead to negative amortization, and should provide their borrowers with quarterly statements with details such as collected principal and interest to date, current EMI amounts, remaining EMI amounts and APR (Annual Percentage Rate) of their loans that should be easily understandable to them.
Applicability to Different Loan Types
These directives don’t just apply to loans with equal monthly installments; they apply equally well for installment loans with different periodicities. When lending against external benchmarks using the External Benchmark Lending Rate (EBLR) framework, banks should also abide by these guidelines and implement information systems that monitor how changes to benchmark rates affect lending rates.
Timely Implementation
REs are responsible for implementing these directives by December 31st, 2023 for both existing and new loans, providing existing borrowers with communication via appropriate channels outlining their options and communicating them to existing borrowers as needed.
Conclusions
The RBI guidelines, born of clarity and fairness, represent a significant step toward creating a more transparent and equitable lending environment. By adhering to these directives, financial institutions can build borrower trust while offering informed choices in India’s flourishing financial ecosystem. As more information and options become available to borrowers, they are better equipped to navigate their journey with greater ease.