Floating Interest Rates

What’s in today’s article?

• Why in News?
• About Floating Interest Rate
• Floating Interest Rate vs. Fixed Interest Rate
• Advantages/Disadvantages of Floating Interest Rate
• News Summary
• What is the Need to Introduce a Framework for Monitoring Floating Rate Loans?
• RBI’s Plan

Why in News?

• Recently, the Reserve Bank of India (RBI) announced that it will bring a framework of transparency and proper rules while resetting Equated Monthly Instalments (EMIs) based on floating rate loans.

About Floating Interest Rate

• A floating interest rate is an interest rate that changes periodically.
• The rate of interest moves up and down, or “floats,” reflecting economic or financial market conditions.
• Often, it moves in tandem with a particular index or benchmark, or with general market conditions.
• A floating interest rate can also be referred to as an adjustable or variable interest rate because it can vary over the term of a debt obligation for example house loan.

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Floating Interest Rate vs. Fixed Interest Rate

• A floating interest rate contrasts with a fixed interest rate.
• With a fixed interest rate, the rate is constant and doesn’t change. It might apply to the entire term of the loan or debt obligation, or for just part of it.
• Home loans can be obtained with either fixed or floating interest rates.
• With fixed interest rates, the loan interest rate is static and cannot change for the duration of the loan agreement.
• With floating or variable interests rates, the loan interest rates can change periodically with the market.

Advantages/Disadvantages of Floating Interest Rate

• Advantages –
  • Payment flexibility of at any time without any penalty.
  • In case the interest rates drops, a borrower can pay off the loan faster.
  • It is generally lower than fixed interest rate.
• Disadvantages –
  • Dynamic & unpredictable.
  • Budgeting becomes difficult for both lender and borrower.
  • When market conditions are adverse, financial institutions charge high premiums from customers.

News Summary

• The Reserve Bank of India (RBI) said it will put in place a framework to ensure greater transparency in resetting interest rates and tenors on floating rate loans, like housing loans.

What is the Need to Introduce a Framework for Monitoring Floating Rate Loans?

• Supervisory reviews by the RBI, and feedback and references from the public have revealed several instances of unreasonable elongation of tenor of floating rate loans by lenders without proper communication and consent from borrowers.
• Banks can change the interest rate by changing the internal benchmark rate and the spread during the term of the loan – potentially harming borrowers’ interests and impairing monetary transmission.
• Borrowers have complained that banks change or reset EMIs arbitrarily, and extend tenors without informing them. Borrowers are also not informed about foreclosure charges.
• Also, floating rate loans of different banks with internal benchmarks are not identical.

RBI’s Plan

• A proper conduct framework will have to be implemented by all regulated entities (including banks and NBFIs) to address issues faced by borrowers.
• The framework will require regulated entities to –
  • clearly communicate with borrowers for resetting the tenor and/or EMI;
  • provide options for switching to fixed rate loans or foreclosure of loans;
  • disclose various charges incidental to the exercise of the options; and
  • ensure proper communication of key information to borrowers.
• These measures will further strengthen consumer protection.

Q1) What are Non-Banking Financial Companies (NBFCs)?

Nonbank financial companies (NBFCs) are entities that provide bank-like financial services but don’t hold a banking license. As per RBI Act 1934, Reserve Bank of India (RBI) has the powers to regulate and control the NBFCs.

Q2)  What do you mean by NPA in Banking?

Non-Performing Assets (NPAs) are loans or advances issued by banks or financial institutions that no longer bring in money for the lender since the borrower has failed to make payments on the principal and interest of the loan for at least 90 days.

Source: RBI seeks greater transparency in floating interest rates of retail loans  | ET | Investopedia