RBI justifies ban on pre-payment charges

The Reserve Bank today justified its move to ban pre-payments charges on floating rate loans, saying there is no legitimacy for banks to levy any penalty in such loan contract.

"In a floating rate contract, the borrower bears the complete interest risks and cannot be asked for compensation if he decides to pre-pay. On the other hand, in a fixed rate contract, the lender is committing resources, and then there is some legitimacy in asking for compensation," Deputy Governor Subir Gokarn told reporters on the sidelines of a FICCI event here.

Yesterday, the Banking Ombudsmen had suggested that banks need not impose any charges for pre-paying loans taken under floating rates by customers.

Many banks charge a pre-payment penalty ranging from 2-3% if a borrower chooses to  pre-pay personal or home loan, irrespective of the nature of the loan contract-floating or fixed rate loans, citing as part of their cost of servicing their own loans.

"Floating rate loans pass on the interest rate risk from banks, which are much better placed to manage it, to borrowers and, thus, banks only substitute interest rate risk with potential credit risk," the Ombudsmen noted.

The banks will, however, be free to recover or charge appropriate pre-payment penalties in the case of fixed rate loans, the 10 action points to improve customer service said.

The Banking Ombudsmen  met at the RBI yesterday along with IBA representatives.

Though the suggestion of the Banking Ombudsmen are morally suggestive in nature, it is generally accepted by the banks. Technically speaking, their suggestions have to be followed up by a circular from the RBI.

In his inaugural remarks Governor D Subbarao had said "often, prevention was better than cure. In customer service area too, rendering good customer service was like 'prevention' and was better than the 'cure' which was the various grievances redressal mechanisms."

Minister of State for Finance Namo Narain Meena in a written response in the Rajya Sabha too had said yesterday that the government in May 2010, had advised PSBs, IBA and National Housing Bank that no pre-payment charges may be levied by the lending institutions when the loan amount is paid by borrowers out of their own funds.

State run banks like SBI claim that they do not levy any pre-payment charges if the pre-payment is paid by the borrowers from own sources, and not re-financed by another lender.