Banks could introduce and popularise fixed-rate long-term loans with a provision to reset rates periodically (say, every 7-10 years), said a Reserve Bank of India panel.
The loan product will be in addition to the plain-vanilla fixed-rate loans for long tenure, according to a report of the committee set up to assess the feasibility of introducing more long-term fixed-rate loans.
While executing the original loan agreement, the lender could fix a cap and floor (say, 2 or 3 percentage points) at the time of reset in relation to the interest rate originally charged.
Such limits would protect both customers and banks from the risks arising out of adverse interest-rates movements. However, banks should take care that the resetting of interest rate does not violate the regulatory guidelines on base rate.
The central bank has sought introduction of fixed-rate long-term loans because at times customers fail to understand how floating interest rates work.
Banks may raise resources through long-term bonds to enable them to extend long-term fixed-rate loans. Banks are permitted to raise long-term bonds with a minimum maturity of five years to the extent of their exposure to infrastructure sector loans with residual maturity of more than five years.
The panel said the banks which have not issued such bonds to the extent of their said exposure to the infrastructure sector could issue more bonds, which would help release resources for extending long-term fixed-rate loans. The segment qualifying for raising resources through long-term bonds could also be enlarged to include exposure to housing loans qualifying for priority-sector lending. This will facilitate banks to extend fixed-rate loans ranging from 15 to 20 years.
30-year bonds
As the Indian financial system has Government securities of up to 30 years’ duration, these bonds could be used as a benchmark to issue and price 30-year bonds by banks. Banks could, therefore, make efforts to offer longer-tenor fixed-rate loans, say, up to 30 years which would help reduce EMIs.
Banks should popularise fixed-deposit schemes with tenors of above five years as they are eligible for tax exemption. This would to some extent meet the long-term funding requirement.