The Reserve Bank of India (RBI)’s proposal to ask lenders — banks as well as shadow banks — to refrain from imposing a pre-payment penalty should make life easier for micro and small enterprises. This would be essentially for floating rate loans of up to Rs 7.5 crore typically taken by small enterprises to run their businesses and to individuals for products such as loans against property. In fact, the central bank doesn’t want even a minimum lock-in period before the pre-payment penalty kicks in. The RBI’s stance on foreclosure penalties for floating rate home loans to individuals was similar and it had barred lenders from imposing such charges. While acknowledging that small enterprises need to be supported with affordable credit that they can easily access, the RBI has highlighted that lenders appear to have varying rules when it comes to levying pre-payment penalties and these have left customers unhappy and resulted in disputes. In particular, the central bank’s draft circular speaks of “restrictive clauses” that are built into the loan agreements by some lenders. These riders prevent borrowers from switching to another lender either for lower interest rates or better services.
Even as feedback on the circular is awaited, disallowing foreclosure or pre-payment charges is a good move and will undoubtedly benefit borrowers. Most large banks do not charge penalties or foreclosure charges on floating rate loans though many smaller ones do. However, it is largely the non-banking financial companies (NBFCs) which lend to small enterprises and also offer products like loans against property that levy penalties. The absence of pre-payment charges will prompt many borrowers to switch to other lenders that offer better terms via what is commonly known as balance transfers. While the larger banks typically cater to the slightly bigger medium enterprises — loans above Rs 7.5 crore — some of the smaller banks might wean away customers from NBFCs by offering customers finer rates. Inherently banks have an advantage over NBFCs in that their cost of funds is lower. As such, the intensifying competition should see rates moderating.
There is no doubt that smaller enterprises deserve the best possible terms and it is unfair that lenders should try to hold on to them by imposing pre-payment charges. At the same time, shadow lenders and housing finance companies are playing an important role in reaching out to borrowers who have not been able to access formal funding. If their fee incomes take a hit — as they will — they might become less inclined to lend to weaker borrowers or those without a good credit history. As experts point out, assessing the creditworthiness of relatively weak borrowers can be expensive as there is usually not much of a track record and much of the due diligence is done manually. If they lose these customers within a few years they could incur losses.
To make up for the loss of profitability on fees, lenders might raise processing charges, and even spreads, across customers. That would impact rates for all borrowers which is clearly not desirable. As it is the RBI’s stricter rules on bank lending to NBFCs have hurt their businesses. In general, with credit flows tapering off with the central bank frowning on too much unsecured lending, NBFCs need some succour. They need to be compensated, in some manner. Else credit flows to un-banked sections will continue to slow down.
