Wednesday, October 22, 2008

Banks change fixed rate by invoking reset clause

Banks due to liquidity crunch are under pressure to protect their margins and are required to review the pricing and structure of loans. Earlier loans which had a fixed rate of interest were considered to be insulated from interest rate vagaries.

Banks are under pressure to protect their margins and need to review the pricing and structure of loans. Previously, loans carrying a fixed rate of interest were considered to be insulated from interest rate vagaries. Therefore they are supposed to remain neutral to the changes in the market rates of interest. Hence increase in the interest rates, have entailed a loss of banks.

Banks have introduced the reset clause in their fixed home loan documents to result in change in the interest rate at a future date. A reset clause permits banks to review rates at the end of certain number of years. In the housing loan agreements the reset clause is either explicitly or implicitly. The clauses come into effect at the time of increase in the interest rates. Effectively, this makes the fixed rate loans equivalent to floating rate ones.

The reset clause also enables banks to revise their interest rates on the loans in case of certain circumstances. Under this clause the banks have the discretion to increase the interest rates in case the market rates increase. This gives the banks a escape against interest rate increases at a future point in time. But it is a disadvantage for the borrower.

The interest rate on fixed is higher than the floating rate because there is an additional element of risk, which the bank has to bear in the future. Generally, people opt for fixed rate loans when the interest rates are low therefore they prefer to lock-in the interest rates for the long term. Originally, banks were offering these loans without any apprehensions of any radical increases in interest rates in the future. But, as the interest rates started going up, banks are introducing the reset clause.

However the interest rate reviews and hikes can be linked to various factors - the prime lending rate (PLR) of the bank, money market conditions and so on. Furthermore, the increases might apply to select borrowers - loans above a certain amount or loans for certain tenure. The tenor of review and increase in the interest rates may be mentioned - once in a quarter or once in six months.

Recently the interests rates have gone up subsequently therefore banks are increasingly introducing the reset clauses to increase the interest rates on the fixed rate loans as well.

Monday, October 13, 2008

Banks not offering loans for gold purchase

In India it is a festival time and the celebrations are on full swing new clothes to buy, new appliances, even buying a new car. At this time banks also promote gold coin purchases at bank branches. But most of the banks have not included loan offer for purchasing of gold or gold jewellery in their portfolios.

However Indian Overseas Bank and Corporation Bank are offering loans to purchase gold and platinum jewellery, some banks like Canara Bank are offering discounted loan offer for purchases.

According to industry experts these products are not consumer friendly. "Banks currently offer loan for gold purchases to only government employees or those who have a salary account with them. The loan is available only for buying gold bars, not jewellery," says Keyur Shah, associate director of the World Gold Council.

Though the World Gold Council is having talks with several banks and national gold jewellers for making available gold purchases via equated monthly installments (EMIs).

"In times of volatility and global crises, gold jewellery purchases on EMI would be beneficial. We have been talking with banks and national players to offer gold on EMI," says Shah.

He raised a question, "Affordability is a factor in gold purchases. When loans are available to purchase consumer durables, home, etc, why not for gold?"

Bankers stated that high risk is involved in the yellow metal. An anonym’s bank official stated, "The prices are volatile and, in case the person defaults, it is not as easy to recover a gold asset as it is to recover a home or vehicle."

But Shah is not convinced about this. He added, "If security and risk can be taken care of in the white goods industry, it can be taken care of in the gold industry as well".

Jewellers pointed out that they haven't seen too many purchases by takers of gold loans as the loans are not consumer friendly.

"Banks have restrictions for offering gold loans. Unlike a personal loan or a consumer durables loan, a loan for buying gold jewellery is not sustainable. Unlike a television, which sees a significant drop in value once it is purchased, in the case of gold, the value may even increase after it's bought. Gold is a liquid asset and can be moved and so structuring a product may not be possible," says V Govindraj, VP, integrated retail services at Tanishq.

To get a gold loan, for amounts beyond Rs 50,000, a security such as LIC policy, Kisan Vikas Patra, National Savings Certificate has to be kept with the bank. Therefore if you are looking for taking a loan of Rs 1 lakh, up to Rs 50,000 it will come without security and a security has to be submitted for the balance Rs 50,000.

However jewellers themselves have found an easier way, which operates like the loan facility. Rajiv Popley, director of Popley Group, says, "We have been offering the EMI facility for gold purchases for the past five years through credit cards. We have a tie-up with Citibank and ICICI Bank, under which the EMI facility can be utilized. Most people take this facility."

"There is no down payment required and the interest charged is 0% for three months," explains Popley. "Buying gold is a spontaneous decision and the EMI on credit card facility can be utilized in seconds, while the bank loan is a tedious process. No one would undergo a tedious process when the shopping is spontaneous," he elaborates.

Nevertheless, the EMI on credit card facility that many people are using for gold purchases might not be as low-cost as it appears. Banks are usually charging an interest rate of around 1.5-3% per month, as well as the processing charge for the EMI on credit card facility. Therefore, for a six month EMI option, you will end up paying around 8-9% more than the purchase price. In this world everything has price.