The story behind zero per cent interest EMI schemes

Sep 30 2013, 13:06 IST
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RBI has noted that the interest element is often camouflaged and passed on to the customer as processing fee. RBI has noted that the interest element is often camouflaged and passed on to the customer as processing fee.
SummaryHere's a look at how zero per cent EMI schemes work, and if there is any benefit in them.

In April, Anita Singh, a 50-year-old housewife, purchased a microwave worth Rs 10,100 from a large retailer in Mumbai. The retailer lured her into a six-month easy payment EMI scheme at zero per cent interest rate on her bank’s credit card and told that all she was required to pay was an additional processing fee of Rs 500. Even though she had her savings to pay for it, she went ahead with the deal.

A careful look into the scheme now shows that while the bank converted her payments into six EMIs, she had to pay the initial two EMIs in the first month. So, effectively, it was six EMIs in five months and Rs 500 extra on the purchase of a microwave worth Rs 10,100. A simple calculation shows that the processing fee she paid works out to be an effective interest rate of 11.9 per cent for her purchase and that too upfront.

“I feel cheated. I thought I was being offered the product at zero interest rate but the processing fee is amounting to this high rate of interest,” said Anita, who is a hard bargainer and always looks to get some extra discount on any product she purchases.

Over the last few years, financing institutions, product manufacturers and retailers have come together to design schemes in a bid to make the deal look attractive to the consumer and make it convenient for him/her to pay in a bid to promote sales. However, as these schemes continued to evolve, they have become complex for consumers to understand the benefit and the interest he/she is paying to buy that product. In many cases, the consumer doesn’t even understand the final outgo from his pocket on such purchase.

The Reserve Bank of India, in a bid to keep things simple for the consumer, ensure more transparency on part of the manufacturer, the financier and the retailer and to protect the consumer from such complexities, issued instructions to commercial banks to desist from practices that thwart fair and transparent pricing of products including the most prevalent zero per cent loan and subvention schemes.

schemes on offer

As a means to attract consumers and push their sales, banks along with retailers and manufacturers had designed two types of zero per cent EMI schemes. In one they charged processing fee which RBI says is a way to camouflage the interest element in the loan and in the other (subvention scheme) they did not charge the processing fee or anything from the consumer and the interest component to the card issuer was paid by the merchant or the manufacturer.

In case of zero per cent EMI schemes, RBI has noted that the interest element was camouflaged and passed on to the customer in the name of processing fee and in some cases they would also load direct selling agents commission in the interest rates thereby making it complex for the consumer.

“Since the very concept of zero per cent interest is non-existent and fair practice demands that the processing charge and RoI (rate of interest) charged should be kept uniform product/segment wise, irrespective of the sourcing channel, such schemes only serve the purpose of alluring and exploiting vulnerable customers,” said the RBI.

Several card issuers have already discontinued such schemes and say that it was not in the best interest of the consumer.

“I fully agree with RBI’s advisory to discontinue the scheme that charged interest rate in the guise of processing fee etc and we have already discontinued that scheme,” said Pallav Mohapatra, CEO, SBI Cards.

The RBI has also issued advisory against zero interest EMI schemes (under subvention schemes) that do not have any processing fee but card issuers say that the only issue that may be upsetting the regulator is on the front that card issuers do not tell the consumers upfront that the interest to them will be paid by the merchant or manufacturer for their purchase.

Card issuers are also looking to approach the RBI to let them continue with the subvention schemes as its benefits everyone and they will on their part make full disclosure to consumers that interest payment for their purchase is being taken case either by merchant or the manufacturer.

The RBI has, however, argued that under the subvention scheme it is banks’ responsibility to make consumers fully aware of the bargain that they would get from the manufacturer or retailer and also pass on those benefits fully and indiscriminately.

“Thus in principle, banks should not resort to any practice that would distort the interest rate structure of a product as this vitiates the transparency in pricing mechanism which is very important for the customer to take informed decision,” said the RBI.

While some say that stopping such schemes would lead to a cut in spending of up to Rs 20,000 crore per annum, some manufacturers say that it won’t impact much.

“While only 25 per cent of consumer durable secondary sale is through consumer finance, 75 - 80 per cent of automobile secondary sale is through consumer finance. Hence, impact is more on automobiles not durables. Also, consumer durable finance is primarily through NBFCs, not banks, while automobile finance is routed majorly through banks,” said Deba Ghoshal, marketing head, unitary product business group, Voltas.

Other than these, the RBI has also instructed banks to put a curb on the practice where merchant establishments levy fee as a percentage of the transaction value as charges on customers while they make payments for purchase through debit cards. “Such fee are not justifiable,” said RBI adding that this calls for termination of relationship of bank with such establishments.

The RBI has raised an alarm once again to protect consumers but one needs to be careful on occasions when retailers dangle schemes which may look attractive but may ultimately prove to be a bad financial decision.

Buyers, therefore, need to be very careful before falling into the zero per cent interest rate trap and spend some time doing their maths in order to understand how much they are paying for a facility that looks very attractive from the outset.

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