By Srinath Sridharan
The dilemma surrounding what constitutes a fair interest rate has been a long-standing debate in finance. For decades, regulators, lenders, and consumers alike have grappled with this complex issue. While the core principle of fairness in lending is universally accepted, the parameters for defining “fairness” have remained elusive. The evolution of lending models, particularly with the rise of non-bank lenders, has added layers of complexity to this intricate discussion.
As the Reserve Bank of India (RBI) takes a more active role in addressing usurious lending practices, it is evident that consumer protection and transparency remain paramount. However, fairness in loan pricing is not merely about capping rates; it requires a formulaic approach that balances consumer interests with the sustainability of lenders.
The purpose of any lending institution is to serve its consumers, enabling access to credit that fosters growth, opportunity, and financial inclusion. But this mission cannot ignore business realities. Loan pricing is a multi-dimensional challenge. Innovations in lending models have expanded access to credit, especially for underserved segments. Yet, these have brought complexity to the calculation of fair rates. Loan pricing encompasses various components, including interest rates, processing fees, contingent charges, and ancillary costs such as insurance. Lenders incur costs ranging from capital requirements to credit risk, operational expenses, write-offs for bad loans, and technological investments. If these costs cannot be reasonably recovered alongside a fair return on equity, lenders do not have purpose to stay in the market. As the American economist Milton Friedman once said, “The business of business is business.” In the absence of profitability, even the noblest missions cannot be sustained.
A regulatory framework must, therefore, acknowledge the dual imperatives of consumer protection and lender viability. Pricing models in lending are complex, reflecting several components: base interest rates, processing fees, contingent charges, and ancillary costs like insurance premiums. Without clear regulatory guidance, lenders are left to interpret fairness independently.
The RBI should consider defining a structured formula for fair loan pricing. This formula could incorporate variables such as the cost of funds, credit risk premiums, administrative expenses, and a reasonable profit margin. For instance, the Bank for International Settlements highlights that fair interest rates should align with economic fundamentals, inflation-adjusted costs, and credit risks, all while promoting systemic stability. By codifying these principles into an operational framework, the RBI could eliminate ambiguity.
The concept of a FAIR interest rate goes beyond numbers — it embodies a framework for accountability, integrity, and reasonableness. A fair rate ensures clarity and accountability in pricing decisions, allowing borrowers to understand and trust the terms of loans. It reflects integrity by protecting consumers from exploitative practices while supporting transparency in transactions.
Transparency is the bedrock of fairness. Borrowers must have complete clarity on all costs — interest rates, processing fees, and ancillary charges — without hidden surprises. Processing fees, in particular, require standardisation. These fees are often justified as covering documentation, manpower, or technology costs, but their variability across institutions raises questions about fairness.
Equally important is the need for pricing policies to be dynamic. Boards of lenders must regularly review their pricing models — quarterly at a minimum — to adapt to changes in credit risk, liquidity costs, and economic conditions. Any cost efficiencies arising from economies of scale or improved credit ratings should be passed on to borrowers, as fairness is not just about transparency but also equity.
A robust framework must also account for the borrower’s total cost of credit, including bundled products like insurance. While such products can provide valuable protection, they must not inflate the effective cost of borrowing unfairly. Regulatory clarity on permissible bundling practices would address concerns over opaque pricing.
Finally, the sustainability of the lending sector is important for regulatory watch. As much as consumers require protection, the sector must also see their business models thrive. A healthy post-tax return on assets, typically within 3-5%, is essential to attract capital and maintain focused lending. Without this balance, the market risks losing lenders, pushing borrowers into higher-cost alternatives or depriving them of credit altogether.
A fitting analogy is that of traffic cops who station themselves just beyond a signal, often hidden behind a parked vehicle or tree, ready to flag down violators and issue penalties. Without formal guidance on fair interest rates, the industry fears that the RBI’s supervision might appear similarly reactive — catching missteps rather than providing a clear road map. To avoid such perceptions, it would be far more constructive for the RBI to set explicit guidelines, ensuring lenders know the rules of the sectoral road and can drive their practices accordingly.
Even the boards of lending institutions appear uncertain about the principles and formulas for fairness, with many deeming their current practices as justified. This disconnect highlights the urgent need for regulatory clarity. It would be prudent for the RBI to issue definitive guidance on this matter — perhaps similar to its approach with microfinance institutions.
Regulatory guidance is not a constraint but actually a compass — steering businesses, markets towards fairness, transparency, and sustainable growth, where innovation can thrive without compromising integrity. There is a keen interest and hope that the RBI would lead with a structured framework that removes second-guessing what’s fair in loan pricing.
The writer is policy researcher and corporate advisor.
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