Home loans need a more stable benchmark

Household Finance Committee provides suggestions on how participation of households can be enhanced

Have you ever tried shopping for a home loan? Chances are that you would be totally confused. While the basic benchmark, the marginal cost of funds-based lending rate (MCLR) stays the same, most banks use different tenures to calculate the rate. Some, like State Bank of India and Punjab National Bank use one-year MCLR while others like HSBC and Citibank use 3-month as benchmark. And some like ICICI Bank use two benchmarks — 6-month and one year MCLR. Then, there are different offers that give some 10 basis point benefit for women and so on.

Against this backdrop, the Reserve Bank of India (RBI)-appointed Household Finance Committee, headed by Tarun Ramadorai, has produced a report that offers a comprehensive set of suggestions on how the participation of Indian households in formal financial markets can be enhanced. And, one of its main targets is the home loan sector. 

Link home loans to repo rate: Since April 1, 2016, the benchmark used for determining the home loan rate has been the marginal cost of funds based lending rate (MCLR). Despite the switch from base rate to the MCLR regime, the home loan rate does not decline rapidly when interest rates within the economy are falling. One reason is that the home loan rate is linked to the MCLR, which is controlled by banks. The committee has suggested that it should be benchmarked to the repo rate, a well-known and widely-publicised rate.  Experts disagree on the finer points of this suggestion. Says Manoj Nagpal, chief executive officer (CEO), Outlook Asia Capital, “If you do want to link the home loan rate to a more transparent benchmark, it has to be a market-determined rate, such as the 10-year G-Sec, and not an RBI-determined rate.” He adds that the repo rate and market-based rates sometimes move in opposite directions. 

According to Naveen Kukreja, CEO and co-founder, Paisabazaar.com, the suggestion to make banks quote RBI’s repo rate instead of their own MCLR rates will definitely make loan rate comparison easier for borrowers. However, he adds: “This may not help borrowers to avail of reduced rates as the actual rate charged by banks depends on the borrower's profile, income, credit score and various other factors.” 

The committee has also suggested that the loan rate should reset after every one month to ensure faster transmission. “The borrower should be allowed to decide what he wants at the time of taking the loan. If he wants a more stable home loan rate, he should go to a bank like SBI which links its home loan to the one-year MCLR. On the other hand, if he wants his home loan rate to change more often, he should go to a bank that links it to the three-month MCLR. The one-year MCLR is a disadvantage only when rates are going down, not when rates are going up,” says Nagpal.

Lack of trust in financial institutions: The Committee noted that the average Indian household holds 84 per cent of its wealth in real estate and other physical goods, 11 per cent in gold and the residual 5 per cent in financial assets such as deposits and savings accounts, publicly traded shares, mutual funds, life insurance and retirement accounts).  In comparison, retirement assets account for large shares of wealth in Australia (23 per cent) and the UK (25 per cent). 

The lack of trust in financial institutions partly explains the tendency of households to avoid financial products and invest in physical assets such as gold instead. “People avoid financial assets such as mutual funds, stating: ‘I feel it is too risky and I’ll eventually lose money,’ and appear to view gold as a relatively safe asset. However, we note that the move towards gold may not solely be because of the pull of gold, but also because of a push away from other products,” says the report. 

According to experts, the main problem is that risks aren’t well articulated by financial institutions. The basic investment product is the fixed deposit, but banks don’t really advertise them. So several perceptions and myths exist. And rampant mis-selling in insurance sector takes away the trust. “The risk and taxation structure of financial products is quite inexplicable at times. For example, the Public Provident Fund is the most tax efficient product whereas pension products aren’t as efficient. Ideally, pension products should be most tax-efficient,” says Ashvin Parekh of Ashvin Parekh Advisory Services.    

Right-based approach to data privacy: With the Aadhaar and privacy debate at its peak, the committee makes useful suggestions. In the course of their work, financial institutions collect a vast amount of personal and private data which gets misused sometimes. The committee says that India should consider moving from a consent-based approach to a rights-based approach. Currently, all that institutions have to do is get the customer to sign a consent agreement. Having obtained the consent, they are free to use the data in any manner they like. “In most such transactions, one party has much greater bargaining power,” says Udbhav Tiwari, policy officer at the Centre for Internet and Society, Bengaluru. Hence, the client meekly signs the consent agreement. “A rights-based approach to privacy would mean that the right to data privacy is not something that a person can consent away,” says Tiwari. While the institutions that collect the data will be able to use it for specified purposes, they could be held liable if they use it for purposes deemed violative of the customer's right to privacy.

Electronic Know Your Customer (e-KYC): The committee has said that a major impediment to the widespread adoption of e-KYC is that there is uncertainty in firms' interpretation of regulatory norms about electronic verification and settlement. This is due to opaque communication between firms and the regulator. Hence, firms are over cautious. For instance, even in cases where wet signatures are not required, they enforce it on customers. According to experts, another problem with the current KYC regime is duplication of effort. “An intermediary who registers a completely fresh investor in mutual funds is currently required to register his details with two KYC agencies–CERSAI and a KRA (KYC registration agency). This is massive duplication of effort with no conceivable benefit,” says Kunal Bajaj, founder and CEO, Clearfunds.com.