Many of us ponder How banks deal with a cut in home loan rate?

The answer is, it is challenging for the majority of banks. It is real that many borrowers who availed the home loans during the low-interest scheme are now facing higher Equated monthly instalments (EMIs) and enthusiastically anticipating the decline in home loan interest rates.

It is also true for many potential borrowers waiting for home loan interest rates to drop so that they at least spiralling home prices are declined to a certain degree.

But given the costs of funds, lending costs and the amount of returns from the portfolio of home loans, it may well be a surprising challenge for banks to allow lower interest rates, say 10% to 11% per year, particularly for those charging lower home loans rates.

With inflation rising higher – the figures suggest that inflation has passed the 5% level. And it would be difficult for banks to reduce the interest rate on deposits. Consequently, their funding expenses will remain high. There is also no variation in service charges between accounts with larger amounts of loans and lower amounts of credit.

Through the smaller loan accounts and particularly in the loan category up to ₹ 20 lakhs, servicing costs are thus higher as a proportion to the loan amount. Also, the rise of NPA rate in the home loan portfolio places strain on the earnings from this portfolio.

Because of the above scenario and because the majority of banks’ credit portfolio (80%+) depends on home loans less than ₹ 20 lakh, any interest rate declines for these borrowers are likely to affect banks drastically.

But since the interest rate for different banks ranges considerably from 9% to 13% annually for loans borrowers up to ₹ 20 lakh, banks charging comparatively higher interest rates should look at the possibilities of cutting interest rates, taking into account lower risks associated with this immovable real estate. It seems a difficult proposition for the majority of banks to cut home loan rates.

Forced rate reductions will harm the economy

Commercial banks’ housing loan payouts in FY07 amounted to approximately ₹ 45,500 crores, a rise of about 25% from the previous year. RBI data indicates that, as of November 23, 2007, outstanding home loans rose by about 15 percent to ₹ 2,46,700 crore. Despite the growth, housing loans are roughly 8.6 percent GDP-ratio compared with over 50% in developed economies. The home loan prices are based on a variety of variables such as long tenures(15 years average), the interest rate and the borrower’s creditworthiness. Besides, selling home loans determines the curve of the lending cost and affects short-term pricing of credit.

Declining interest rates would allow homeowners to refinance their loans for fixed-rate housing loans and thus raise the cost of home loans. There are also charges applied in case of home loan default. In the loans section, defaults occur when the borrower cannot pay due to the changes in the external environment.

Also, housing loans are potentially the most priceless commodity in India. They are one of the most critical components of the credit portfolio of banks (22.4 percent of total bank credit as of November 2007). There is also little information on mortgage loans that can be used with price credits. Absence of a good credit bureau often limits the ability of banks to disclose the borrowers’ credit records.

Conclusion: Any persuasion or excessive pressure on the banks to reduce their home loan prices can thus, at least in the medium term, be harmful to the economy as a whole. We have to see the capability of government control banks on this and how banks respond to it, provided that the majority shareholder in PSBs (still makeup about 70 percent of the sector in terms of assets).

Lois Reed