Shares of non-banking financial companies (NBFCs) and banks fell 1-3% on the BSE in the early trade on Monday, after the Reserve Bank of India (RBI) on Friday proposed removing charges on floating-rate loans for retail and MSME borrowers, raising concerns about a potential impact on interest income.
Among lenders, NBFCs were hit hard, with shares of Poonawalla Fincorp, Cholamandalam Investment, Piramal Enterprises, Aditya Birla Capital, PNB Housing and Shriram Finance declining 2-3% percent. Shares of ICICI Bank, HDFC Bank and IndusInd Bank fell by 1%.
Analyst say the move will benefit borrowers and might to lead to more churn in the banking industry. If implemented, proposals could hurt income from foreclosure charges and result in the profit being hit, Morgan Stanley analysts, including Subramanian Iyer, said in a note. “Further, this could also increase propensity of borrowers to churn,” it said.
Currently, retail borrowers face a penalty of 4-5% on the outstanding principal for prepaying personal loans, while MSMEs are required to pay loan foreclosure or pre-payment charges in the range of 2-4%.
“Banks and NBFCs will need to reassess their asset-liability management strategies. This could involve diversifying loan portfolios to include more fixed-rate instruments, which are less susceptible to prepayment risks, or enhancing focus on fee-based services to compensate for the potential decline in interest income,” said a senior official of a private bank.
The removal of pre-payment penalties is likely to reduce lenders’ interest income, as these penalties are typically classified as part of interest income, he said, adding that lenders may raise processing fees or other charges to offset the loss.
Analyst say the draft proposal will encourage lenders to offer more competitive interest rates and increase emphasis on customer relationship management to retain borrowers.
“With no pre-payment penalties, individuals and MSEs might more readily switch lenders to secure better rates, intensifying competition. This could lead to a race to the bottom in loan pricing, affecting long-term profitability. Additionally, the proposal might encourage more borrowers to prepay loans using surplus funds, altering the dynamics of loan portfolios and asset-liability management for lenders,” said a banking analyst with a brokerage firm.
The RBI on Friday released a draft circular proposing to remove foreclosure charges or pre-payment penalties charged by banks and other lenders on all floating-rate loans, including those for business purposes, availed of by individuals as well as micro and small enterprises. In the case of micro and small borrowers, these instructions shall be applicable up to the aggregate sanctioned limit of Rs 7.50 crore per borrower.