New Delhi (Agency): The Reserve Bank of India (RBI) made a significant announcement on Friday, August 18, directing banks to allow individual borrowers with Equated Monthly Instalment (EMI) loans to opt for a fixed interest rate system or an extension of loan tenure. This move is aimed at protecting borrowers from falling into the trap of negative amortisation due to rising interest rates.
Since May 2022, interest rates have been moving upward after the central bank started raising the benchmark lending rate, known as the repo rate, in a bid to control inflation following the outbreak of the Russia-Ukraine war. This resulted in a 250 basis points increase in the repo rate, leading to a situation where a large number of borrowers faced negative amortisation. In such cases, the EMI becomes less than the interest obligation, causing a continuous increase in the principal amount.
The RBI’s new instructions state that at the time of sanctioning EMI-based floating rate personal loans, banks and Non-Banking Financial Companies (NBFCs) must consider the repayment capacity of borrowers. They must ensure that “adequate headroom is available for elongation of tenor and/ or increase in EMI, if interest rate rises.” Loans such as home, auto, and other personal loans are typically linked to external benchmark rates, like the repo rate.
The central bank has taken this step in response to several consumer grievances received concerning the extension of loan tenor or increase in EMI amount for EMI-based floating rate personal loans. Many complaints cited improper communication or lack of consent from borrowers.
RBI’s circular to banks and NBFCs, including housing finance companies, stated, “At the time of reset of interest rates, REs (regulated entities) shall provide the option to the borrowers to switch over to a fixed rate as per their Board-approved policy. The policy…may also specify the number of times a borrower will be allowed to switch during the tenor of the loan.”
Furthermore, RBI has emphasized that regulated entities should clearly communicate to borrowers about the potential impact of changes in benchmark interest rates on their loans. Such changes may lead to variations in EMI and/or loan tenure. “Subsequently, any increase in the EMI/ tenor or both on account of the above shall be communicated to the borrower immediately through appropriate channels,” the RBI added.
Banks and NBFCs must comply with these instructions for both existing and new loans by December 31, 2023. Borrowers should also be given the choice to opt for an increase in EMI, an extension of tenure, or a combination of both, as well as the ability to prepay either partially or fully at any point during the loan’s term.
The new directives also stated that “REs shall ensure that the elongation of tenor in case of floating rate loan does not result in negative amortisation.” Additionally, regulated entities should provide borrowers with a statement at the end of each quarter containing essential details like principal and interest recovered to date, EMI amount, number of EMIs left, and the annualised rate of interest for the entire loan tenure.
This initiative by RBI signifies an essential step towards safeguarding the financial interests of individual borrowers. Amid the increasing interest rates and the complexities of the global financial landscape, the decision to provide fixed-rate options or extension of loan tenure offers a supportive framework for borrowers. It fosters transparency and ensures that the challenges faced by borrowers in navigating variable interest rates are minimized. The move reflects a consumer-centric approach, promoting more informed choices and financial stability for the Indian populace.
