SBI wants to bring back teaser loans, but will it get RBI nod?

The country’s largest lender is making another attempt at bringing back the so called 'teaser loans' as the banking industry gears up to meet the deadline for linking loans to an external benchmark.

State Bank of India (SBI) Chairman Rajnish Kumar said the lender will be seeking clarifications from the Reserve Bank of India (RBI) to see if it can offer home loans with fixed rates in the beginning and convert the same into floating rates later.

This is not the first time that SBI is trying to bring such a product into the market. Its earlier attempts were thwarted by the regulator, which had a different take on these hybrid loans.

What are teaser loans?
Home loans that carry low fixed interest rates for the initial few years and switch to a floating rate framework after a specified period of time are unofficially referred to as teaser loans. However, bankers dread the term and prefer to call them fixed-cum-floating rate loans. Every time interest rates trend low, there are talks of re-introducing the product.

In India, such loans were first launched by SBI in 2009 to boost credit growth and boost the housing construction industry. SBI was offering home loans at fixed rates as low as eight percent for the first year, and nine percent for the second and third years. After that the loan would shift to then prevailing market rates under a floating rate mechanism. A number of lenders followed suit. However, due to much scorn from RBI, these loans were discontinued after a short period.

Why was RBI unhappy with teaser loans?
These loans were called teaser loans for a reason. Banks first use low interest rates to lure or tease the customers into taking loans and then move to higher market rates later. This jump can deliver a nasty shock to borrowers when their EMIs suddenly shoot up.

In fact, RBI mandated banks offering teaser loans to make higher provisioning against such loans. “This practice raises concern as some borrowers may find it difficult to service the loans once the normal interest rate, which is higher than the rate applicable in the initial years, becomes effective,” RBI said in a circular in December 2010. “It has been observed that many banks at the time of the initial loan appraisal do not take into account the repaying capacity of the borrower at normal lending rates,” it added.

So, why is SBI keen on bringing them back?
From October 1, banks have been mandated to link their retail and SME loans to an external benchmark to ensure that banks are able to offer lower lending rates. The existing mechanism of linking rates to Marginal Cost-based Lending Rates (MCLR) has proved ineffective in doing so.

Now, the issue with external benchmarking is that while a fixed rate loan portfolio ensures returns in future, shifting to a floating rate structure will create uncertainties. Also, a fully fixed rate long-term loan isn’t desirable either as rates are on the downtrend.

On the liability side, Indian customers are not used to flexible deposit rates. Also, the interest rate derivative market in the country is not deep enough to help safeguard banks from future fluctuations in the benchmark rate. Bankers say it will be difficult to avoid an asset-liability mismatch in such a scenario.

Will SBI succeed this time?A senior banker referred to teaser loans as an 'illusion' that benefits temporarily at first but causes discomfort when reality strikes in a matter of time.

“There are not many chances that RBI will approve it. Once or twice it has taken views against it, but with a change in guard, there may be a different view, especially if the regulator is only worried about the present,” the official said.

The floating rate structure under external benchmarking also poses similar risks to the borrower. They will be exposed to the volatility in RBI's repo rate, which most banks have opted as an external benchmark. It remains to be seen what the regulator has to say on the return of teaser loans.