Banks are losing their battle for penalty on home loan pre-payments as the Reserve Bank of India sees no case for such a levy given that lenders don’t play a fair game with borrowers. In a meeting with chief executives of banks last week, RBI deputy governor KC Chakrabarty backed the Competition Commissioner of India’s stance that banks waive the clause on pre-payment penalty in mortgage documents since it is anti-competitive, said two people familiar with the discussions at the meet.

If implemented, this would erode one of the key elements of easy profits for banks which charge as much as 2% of the loan amount in some cases.

This is a clear shift in the central bank’s stance of usually backing banks against interference from other regulators, though the RBI itself is strict on banks adhering to norms. Mr Chakrabarty could not be reached for comments.

“There is a case for waiving off penalty on small-ticket loans,” said M Narendra, chairman & managing director at Indian Overseas Bank . Penalty on mortgage pre-payments has become a contentious issue between banks and customers who look out for ways to bring down their cost of funds.

In the two years since 2008 when the central bank cut policy rates more than 5 percentage points, most banks did not pass on lower costs to existing customers, but offered lower rates to new customers. Feeling short-changed by bank practices, customers wanted to change their lenders, but stayed back due to the usurious penalties. New borrowers were offered loans at 8% while existing ones paid around 11%.

A case is pending against the State Bank of India at Supreme Court where some consumers have sought the waiver on pre-payment penalty. The outcome of this case could be crucial in deciding the fate of pre-payment charges, bankers said.

“Banks feel that the pre-payment charges are imposed to negate the impact of interest rate risk and asset liability mismatches of loans,” said MR Umarji, legal advisor to the Indian Banks’ Association.

“The cost of lending is linked to cost of funds and the cost of funds does not vary even as the borrower decides to repay the loan,” he added. The central bank argues that since most of the mortgages are on floating rates, there was no justification that pre-payment leads to losses for banks.

Banks believe that pre-payment charges are disclosed upfront to borrowers and doing away with them would cause an imbalance in their assets and liabilities.

Even the base rate, the new system of pricing loans to best customers below which banks are barred from lending — was introduced in July because the RBI felt the so-called prime lending rate was opaque and banks were not helping in transmitting monetary policy actions.

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