RBI’s New Directive on Loan Interest: A Boon for Borrowers; A Blow for Banks

The Reserve Bank of India (RBI) recently issued a directive that has significant implications for both borrowers and lenders in the country’s banking sector. The new diktat mandates that banks and non-banking financing companies (NBFCs) charge interest on loans only from the date of actual disbursement of funds to customers. While this move is expected to lower loan costs for borrowers, it poses a substantial challenge to the profitability of banks and NBFCs.?

Impact on Banks and NBFCs: A Profit Plunge?

Banks and NBFCs have traditionally earned substantial sums of money by charging interest on loans even before customers receive the funds. This practice, which allowed lenders to charge interest from the date of loan sanction will be curtailed by the new RBI directive. The central bank’s annual inspection revealed instances of lenders resorting to unfair practices in charging interest, prompting the need for regulatory intervention.?

The RBI’s directive aims to rectify the situation by ensuring that interest is charged only from the date of actual disbursement of funds to customers. Previously, lenders would take 30-45 days to finalize a loan agreement, during which time they would freely charge interest despite the funds not being disbursed to the customer. This practice has been a significant source of profits for mortgage lenders .?

Lower Loan Growth and Softer Margin Growth?

Analysts anticipate that the RBI’s directive will result in lower loan growth and softer margin growth, particularly for housing finance companies. The month of April, in particular, tends to be the weakest for mortgage lenders, and the new directive has forced them to reevaluate their sourcing models. As a result, mortgage lenders may experience weaker disbursement momentum, leading to a potential compression in net interest margins (NIMs).??

As of May 2024, the total outstanding home loan amount in India exceeded Rs 27 lakh crore, showing a 40% growth over the previous year. The RBI’s directive is likely to impact the balance transfer of loans as well. Lenders now require a cheque from the borrower to close the loan, which can lead to delays and affect the overall loan transfer process. Some industry officials have suggested alternative solutions, such as obtaining an intimation from the new lender along with an official communication to close the loan, rather than charging the customer during the interim period.?

RBI’s Efforts to Ensure Fairness and Transparency?

The RBI’s directive stems from its commitment to fairness and transparency in dealing with customers. The central bank’s inspection revealed that lenders were charging interest from the date of loan agreement execution, rather than from the actual disbursement date. Additionally, lenders were charging interest from the date of the cheque issued, rather than from the date the cheque was handed over to the customer. Some lenders were also charging interest for the entire month, instead of charging interest only for the period the loan was outstanding.?

The RBI has expressed serious concerns about these non-standard practices and has advised regulated entities to refund any excess interest and other charges to customers. The aim is to ensure that lenders align their practices with the spirit of fairness and transparency while dealing with borrowers.??

A Balancing Act for Borrowers and Lenders?

The RBI's new directive on charging loan interest from the date of actual disbursement is expected to benefit borrowers by reducing their loan costs. However, it will undoubtedly have a significant impact on the profitability of banks and NBFCs, particularly mortgage lenders who heavily relied on interest income before loan disbursement. The directive is likely to result in lower loan growth, softer margin growth, and potential challenges in loan balance transfers.?

While the RBI’s efforts aim to promote fairness and transparency, it remains to be seen how lenders will adapt to the new regulatory framework and navigate the challenges of lower profitability. Borrowers, on the other hand, can expect reduced loan costs and a more equitable lending environment.?

How do you think the RBI's new directive on charging loan interest only from the date of actual disbursement will impact your borrowing experience??