The RBI’s most recent floating rate reset rules (2023) for loans are a welcome development. These new norms are applicable on all existing and new floating rate loans (EMI based) taken by individuals, suitably by 31st December, 2023.
At the time of sanction of EMI based floating rate loans, the financial entities are required to take into account the repayment capacity of borrowers to ensure that adequate headroom/ margin is available for elongation of tenor and/ or increase in EMI, in the scenario of possible increase in the external benchmark rate during the tenor of the loan.
At the time of sanction, the financial institutions shall clearly communicate to the borrowers about the possible impact of change in benchmark interest rate on the loan leading to changes in EMI and/or tenor or both. Subsequently, any increase in the EMI/ tenor or both on account of the above shall be communicated to the borrower immediately through appropriate channels.
Borrowers must have the option to switch to a fixed rate when interest rates are reset, in accordance with the policy approved by the Board. The policy may also specify the number of times a borrower will be allowed to switch between the Rates during the tenor of the loan.
In addition, borrowers will have the option to prepay in full or in part at any time during the loan’s term or to have their EMIs increased or their tenor extended, or to choose a combination of the two. Pre-payment penalties and levy of foreclosure fees are subject to existing instructions. All applicable charges for switching of loans from floating to fixed rate and any other service charges/ administrative 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 (Registered Entities) from time to time.
REs shall ensure that the elongation of tenor in case of floating rate loan does not result in negative amortization.
Impact of RBI’s new rules on EMI based Floated Interest Rate Loans
Let’s find out how each borrower is affected by these new rules; Type of Loans
All individual EMI-based floating interest rate retail loans are subject to the aforementioned instructions. The fixed rate loans do not come under the purview of the above circular.
The notification does not take into account loans for bullet repayment. These new rules apply to home loans, loans against property, auto loans, microfinance loans, digital loans, and education loans with floating rates. Type of Lending institution
The following financial institutions must adhere to these new regulations: All Scheduled Commercial Banks
Regional Rural Banks
Primary (Urban) Co-operative Banks
State Co-operative Banks and District Central Co-operative Banks
Financial institutions other than banks (NBFCs) Housing Finance Companies (HFCs)
Impact on Loan Eligibility
As per the new rules, the lending institutions has to assess the repayment capacity of the borrowers while sanctioning the loans. This means, even if there are huge hikes of lending rates in the future, the lenders should make sure there is an adequate headroom or margin is available for the elongation of tenor and/or increase in EMI. Under these conditions, lenders may approve loans with stringent underwriting requirements, and bankers may either lower the loan eligibility amount or approve the loan with a higher margin.
