To protect loan borrowers from fluctuations in the rate of interest, and in order to reduce the EMI burden on their shoulders, the RBI has suggested that banks should offer loans that have a 30 year repayment period, besides their existing products. Banks might be able to have a provision for interest rate reset on these loans every 7 to 10 years. However, they must keep the customer’s interest in mind and must not violate the base rate regulatory guidelines.
The KK Vohra panel has stated that the financial system in the country has G-Secs that go up to 30 years. Thus, banks could make an effort to offer fixed rate loans for longer periods of time, up to 30 years. This would reduce the EMI of the loan borrowers. Banks could possibly fix a reasonable floor and cap during the interest rate reset. This would protect both the bank, as well as the borrower from risks of adverse interest rate movements.
It has also been suggested that banks should introduce loan products that are a hybrid between floating and fixed interest rates. The fixed rate loan should comprise a higher proportion of these loans.
Fixed rate loans used to be popular earlier. However, the fall in interest rates made banks focus on floating rate loans. The RBI panel made the observation that most 15 to 5 years home loan products were of a floating nature, whereas auto loans for 5 to 7 years usually were of a fixed rate nature.
As most bank deposits are below 5 years, there might be a mismatch of asset liability for banks if they focus on fixed rate products for longer tenures. To find a resolution, the panel asked banks to issue long term bonds, in the infrastructure sector with a minimum 5 year maturity period.
The panel said that banks should popularize these long tenure schemes of fixed deposit, as they are tax exempted. This way, banks can meet their funding requirements for the long term to some extent.
Even though pre-payment penalty is now banned by the RBI on loans with a floating rate, the panel has considered that banks could charge this penalty on fixed rate loans, though only on the outstanding amount. However, it included that the penalty should be a reasonable amount so that borrowers of fixed rate loans are not discouraged.