CCI to investigate loan prepayment penalty charged by banks

The Competition Commission of India (CCI) is keeping an eye on few of private sector lenders including HDFC Bank, Deutsche Postbank Home Finance and LIC Housing Finance, as they are levying a penalty on consumers who are paying off their loans ahead of schedule.

According to a person closely watching the development in case the CCI found the practice anti-competition, then either the regulator or its appellate tribunal can put ban on this practice across the industry and can also penalize banks for charging the levy. The person informed the regulator is trying to gather information from these institutions. A senior CCI official refused to comment on this.

Replying to an e-mail sent by ET, HDFC, India’s largest mortgage lender said, “....the business of a bank/ financial institution involves borrowing and lending and in the process the lending institution tries to run a matched balance sheet of assets and liabilities. Prepayments are essentially accelerated payments before the schedule. Any prepayment will disturb the asset-liability match and in order to mitigate the negative impact of the prepayments the institutions/banks charge a prepayment charge. Every time when there is a prepayment from the borrowers it will not be feasible for the banks to prepay its lenders as its loan agreement with lenders may either not permit it or permit it only with certain charges, notice period and may be subject to other conditions.” HDFC is charging maximum prepayment levy of 2% of the amount prepaid.

When contacted Deutsche Postbank Home finance, it declined to discuss the issue, stating that the matter was sub judice, while HDFC Bank and LIC Housing Finance, refused to comment on this. Till now no directives have been issued to banks, by the banking regulator on a prepayment penalty. When newsperson contacted, RBI governor D Subbarao said in Mumbai, that complaints regarding levying a penalty will be discussed with the ombudsman.

However some of the lenders inflict prepayment charge only in the cases where customer decided to refinance the loan by borrowing at a lower interest from another institution. An HDFC spokesperson said, “The policies of HDFC have always favored customers prepaying loans from their own savings. For example, there are no prepayment charges on part prepayments up to 25% of the opening balance or if the customer prepays his entire loan after three years from his own savings.” In the last one year when banks began to lower interest rates and also agreed to refinance existing loans to gain market share, then only borrowers came to know about the charges relating to loan prepayment. Early this year State Bank of India, country’s largest lender, initiated with its 8% home loan.

The senior banker pointed out although prepayment levied on fixed interest rate is justified, but according to consumers it is not right to attach these charges with floating rate loans. Moreover, when interest rates come down, not many banks pass on the full benefits to their customers, but they are quick in increasing either the EMI (equated monthly installment) or the loan tenor when interest rates start rising.

Thus due to these levied charges, borrowers who had taken floating rate loans restrain from switching to another lender that is offering a lower rate loan.

On the other hand banks also restrain from giving benefits of lower rates to the existing borrowers, instead they offer cheaper loans to attract new customer. CCI is already looking into prepayment charges for auto, personal and other loans, but in case of home loans the issue seems to be significant which have tenors of as long as 15 to 20 years.

A person familiar with the CCI investigation stated, “Prepayment penalty comes in the way of a customer who wants to close a loan and avail of another loan from a bank that lends at a lower interest rate. It makes such migration economically unviable unless the interest rate differential between the banks is more than the quantum of penalty. Such exit load on loans is an entry-barrier for new products in the market and hence anti-competitive”.

The CCI, will also investigate whether the charging of levying prepayment penalty leads to collusive behavior.