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Reset of Floating Interest Rate on EMI based Personal Loans

Reserve Bank of India (RBI) has issued guidelines on reset of floating interest rate on Equated Monthly Instalments (EMI) based personal loans.

What are the types of interest rates on loans?

The Regulated Entities (REs) can offer all categories of loans / advances either on fixed or floating interest rates basis.

Fixed interest rate loans

  • The interest rate remains fixed for the entire tenure of the loan.
  • It is beneficial to the borrowers in rising interest rate scenario and is advantageous to the lenders in falling interest rate scenario.

Floating interest rate loans

  • The interest rate is reset (i.e. increased / decreased) at periodical intervals during the tenure of the loan.
  • It is beneficial to the borrowers in falling interest rate scenario and is advantageous to the lenders in rising interest rate scenario.

What is External Benchmark Lending Rate (EBLR) regime?

Reserve Bank of India (RBI) had constituted an Internal Study Group (Chairman: Dr. Janak Raj) to study the various aspects of the MCLR system from the perspective of improving the monetary transmission and exploring linking of the bank lending rates directly to market determined benchmarks. The Study Group had recommended a switchover to an external benchmark for effective transmission of monetary policy.

Accordingly, External Benchmark Lending Rate (EBLR) regime was introduced and the following loans were linked to external benchmarks –

  • All new floating rate personal or retail loans (housing, auto, etc.) and floating rate loans to Micro and Small Enterprises extended by banks from October 01, 2019.
  • All new floating rate loans to Medium Enterprises extended by banks from April 01, 2020.

The interest rate under EBLR regime is to be reset at least once in 3 months.

What are the external benchmarks?

The external benchmarks include –

  • RBI policy repo rate.
  • Government of India 3-months / 6-months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL).
  • Any other benchmark market interest rate published by the FBIL.

What are the guidelines on reset of floating interest rate?

  • At the time of sanction, REs shall clearly communicate to the borrowers about the possible impact of change in benchmark interest rate on the loan leading to changes in Equated Monthly Instalments (EMI) and / or tenor or both. 
  • Subsequently, any increase in the EMI / tenor or both on account of change in benchmark interest rate shall be communicated to the borrower immediately.
  • At the time of reset of interest rates, REs shall provide the option to the borrowers to –
    • Switch over to a fixed rate.
    • Opt for enhancement in EMI or elongation of tenor or a combination of both.
    • Prepay, either in part or in full, at any point during the tenor of the loan. 
  • All applicable charges / costs incidental to the exercise of the above options shall be transparently disclosed in the sanction letter and also at the time of revision of such charges / costs by the REs.
  • REs shall ensure that the elongation of tenor does not result in negative amortisation. (Negative amortization means that even after repayment, the amount owed still goes up because repayment is not enough to cover the interest.)
  • REs shall share / make accessible to the borrowers, a statement at the end of each quarter which shall at the minimum, enumerate the principal and interest recovered till date, EMI amount, number of EMIs left and annualized rate of interest / Annual Percentage Rate (APR) for the entire tenor of the loan. 

Which loans are covered under the guidelines?

  • The guidelines are applicable to EMI based personal loans. Personal loan refers to a loan given to individual and consists of –
    • Consumer credit
    • Education loan
    • Loan given for creation / enhancement of immovable assets (e.g., housing, etc.)
    • Loan given for investment in financial assets (shares, debentures, etc.)
  • The guidelines would also apply, mutatis mutandis, to all equated instalment based loans of different periodicities. 

From when are the guidelines applicable?

REs shall ensure that the guidelines are extended to the existing as well as new loans by December 31, 2023. 


References

Reserve Bank of India. (2017, October 04). 'Report of the Internal Study Group to Review the Working of the Marginal Cost of Funds Based Lending Rate System'. Retrieved from https://www.rbi.org.in/Scripts/PublicationReportDetails.aspx?UrlPage=&ID=878

Reserve Bank of India. (2018, January 04). 'XBRL Returns - Harmonization of Banking Statistics'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11199&Mode=0

Reserve Bank of India. (2019, September 04). 'External Benchmark Based Lending'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11677&Mode=0

Reserve Bank of India. (2020, February 26). 'External Benchmark Based Lending – Medium Enterprises'. Retrieved from https://rbi.org.in/Scripts/NotificationUser.aspx?Id=11815&Mode=0

Reserve Bank of India. (2023, August 18). 'Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12529&Mode=0#F1


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