“Loan rates set to be more transparent” screamed newspaper headlines on Thursday after a draft RBI circular asked banks to shift to a “base rate” mechanism from the existing “BPLR” w.e.f April 1, 2010.

The existing “BPLR” structure for pricing floating rate loans has exhibited what bankers politely call “downward stickiness”, which means that the BPLR refuses to go down (or goes down reluctantly and at a slower pace) when bank’s cost of funds fall, though it is quick to go up when their cost of funds go up. In effect existing loan consumers continue to pay higher interest rates even in a falling interest rate market but are forced to pay more when interest rates go up. As taking a loan (primarily home loan) becomes more prevalent it affects millions of middle class households and the furore over this non- transparent method of fixing floating rate loan products has reached feverish pitch.

The banks on their part give a curious argument to justify charging more to their existing home loan consumers whilst doling out lower rates to attract new customers. They claim that as interest rates fall only for the new incremental deposits and since the existing consumers are funded from existing deposits (which are at a higher rate), they cannot be given the benefit of the fall in rates immediately. The reason this argument does not appear wash is because by this token when interest rates rise, only the new customers should be paying the higher rate (since only they are funded from the new high cost deposits) whilst the existing loan consumers should continue to pay less. Of course this never happens.

When interest rates go up, they go up for both the new and old customers. Bankers again have a justification for even this. According to them when interest rates go up their existing depositors break their lower cost deposits to make fresh deposits at higher rates. There is no data presented by them to support this contention (of customer churn old deposits for new deposits at higher costs) and it is difficult to believe that a large body of Indian depositors overcome their legendary inertia just to take advantage of a 0.25% or 0.50% increase in deposit rates.

In any case this completely overlooks the fact that managing the “treasury” is a core function of the bank and it cannot pass on this responsibility (or cost) to its loan customers. Another argument given by bankers is that if the true cost of this “treasury” management was to be included in the loan pricing then all loans will be more expensive to start with (though they will be transparent). I am willing to stick my neck out and say that given the choice between a cheaper but non-transparent loan to a slightly more expensive but transparent loan, most consumers will opt for the latter. In fact this presents a unique opportunity for a consumer bank but more of that later.

Now coming to the draft RBI circular which differs from the recommendations of the Mohanty committee in two very crucial aspects. Firstly the committee had recommended that the “Base Rate” be calculated in a very specific manner with the starting point being the bank’s 1 year deposit rate. What the RBI circular says is “While each bank may decide its own Base Rate, some of the criteria that could go into the determination of the Base Rate are: (i) cost of deposits; (ii) adjustment for the negative carry in respect of CRR and SLR; (iii) unallocatable overhead cost for banks”. In effect each bank will be able to fix its own base rate without necessarily having to justify its calculations. This does not give much confidence that anything much will change from the BPLR dispensation. There have been numerous exhortations from the regulator that BPLR was to be fixed with reference to the cost of funds of a bank.

Secondly the committee had recommended that the Base Rate be revised at least once every quarter which is again not insisted on in the RBI’s draft circular.

So unless something changes dramatically, the expectation that loan interest rates will be fixed in a more transparent manner, is likely to take a long time to realise. There is one (unintended?) impact of the draft circular. The artificial cap on interest rate on education loan may no longer apply and hence this crucial (but risky product from the bank’s perspective) may at last take off.

To conclude here, I think that the path to more transparent loan pricing will have to be traversed through legislation rather than from regulation.

Let’s see if our political class will come to the rescue of the loan consumer whereas regulator has been unable to do so.

The RBI has recently expressed its concern about the teaser loans, stating,

“In the area of housing loans, teaser rates are increasingly being offered which is a cause for concern. I hope banks are ensuring that borrowers are well aware of the implications of such rates and the appraisal takes into account repaying capacity of the borrowers when the rates become normal.”

The point being made was that when the “teaser rate” period is over (2-3 years in most cases) and interest rates shift to the normal floating rates prevalent at that time the consumers may not be able to cope up with the resultant increases in EMIs (especially if, as widely expected, interest rates go up significantly in the meanwhile).

I give a small calculation here for the better understanding of ‘teaser rigmarole.’ Take the case of a typical 30-year-old salaried person with a net salary of around Rs. 40,000. As per the eligibility calculations he would be able to get a loan of Rs. 20,00,000 from State Bank of India (SBI). (See box for eligibility calculation)

How do “teaser rates” work?

SBI who pioneered these loans prefers to call them “Low cost” loans rather than “teaser rate” loans. Whatever be the label, in the Indian context, it has meant loans in which the interest rates are fixed for the first 2-3 years (5 years also in a couple of cases) and which reverts to regular floating rates after the initial fixed interest rate period is over. For example for a loan of Rs. 20 lakhs SBI would charge a fixed interest rate of 8% in the 1^st year and 8.50% in the next 2 years and from the 4^th year onwards it will have a floating rate of 2.75% below SBI Advance Rate (currently 11.75%) effectively meaning that if SBI Advance rate remains where it is today the rate in the 4^th year will be 9% (SBAR of 11.75% minus 2.75% = 9%). The EMI per lakh on this basis works out to Rs. 836 in the first year Rs. 867 in the next 2 years and Rs. 895 after 3 years.

If he went for the normal option of regular floating rate loans he will get an interest rate of 8.75% (EMI per lakh of Rs. 884) and will also be eligible for a similar loan amount of Rs. 20 lakhs.

If we run a simulation to see what happens if the interest rates rise by 2% in 2010, 1% in 2011 and another 1% in 2012 – or a total of 4% in the next 3 years. As a result in the case of the SBI home loan the interest rates from the fourth year goes up to 13%. If he had gone for the floating rate loan the interest rate would be 10.75% (original rate of 8.75% plus 2%) in the first year, 11.75% in the second year and 12.75% for the period after that. The Instalment to Income ratio in both cases go up sharply from 44% to 57% (indicating that a larger proportion of the income will go towards servicing the home loan) at the end of 3 years and in both cases are almost at the same levels. This means that irrespective of the type of loan the degree of difficulty in repayment would be similiar in both the loans if rates increase steeply by 4% over 3 years.  In both cases an 8% annual increase in income will ensure that the Instalment to Income ratio remains at the original levels. Of course in the regular floating rate loan the consumer ends up paying for the increase in interest rates in the first 3 years also.This increase will ensure that the Installment to Income ratio falls back to the mid forty levels that are considered safe by Indian standards.

How is loan eligibility calculated in a “teaser rate” loan?

The loan eligibility is calculated taking into account the EMI after the teaser period is over. As per the above example the EMI per Lakh of loan in the 4^th year would be Rs. 895. Typically the banks assume that 40% to 50% of the net income is available for repayment of home loan. Therefore from the income of Rs. 40,000 about Rs. 16,000 (40% of Rs. 40,000) to Rs. 20,000 (50% of Rs. 40,000) is available to be paid as an EMI. Based on an EMI repayment capacity of Rs. 16,000 to Rs. 20,000 and an EMI per lakh of Rs. 895 we can back calculate the loan eligibility amount at Rs. 18 lakhs to Rs. 22 lakhs or say around Rs. 20 lakhs.

So clearly whether the consumer chooses the “teaser rate” product or the regular floating rate product he would face some difficulty if interest rates rise steeply as the IIR will increase to uncomfortable levels of 55%+. The IIR can fall back to reasonably comofrtable levels if net income rises by 8% p.a. which should not be a big issue if our overall economic growth  does not falter.

What would perhaps help, both banks and consumers, is if a transparent regime is put in place to ensure that increases in interest rates (and decreases for that matter) are worked out on a transparent and objective basis so that consumers are better prepared for such increases and the actual increase doesn’t come as a shock to them.

The Reserve Bank of India has hiked the Cash Reserve Ratio by 0.75% to 5.75% (as against the existing 5%) in the third quarter review of monetary policy announced today which will be implemented in two stages. The Central Bank has left unchanged the Reverse Repo, Repo, and Bank rate at 3.25%, 4.75%, and 6% respectively.

So what does all this translate into for customers like you and me?

For what is CRR and how it affects interest rates, please see box.

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What is Cash Reserve Ratio (CRR)? Banks are mandated to keep certain percentage (now increased to 5.75%) of their deposits with RBI. This is the Cash reserve and the %age required to be kept as a cash reserve is called Cash reserve ratio or CRR. Thus, an increase in the CRR leads to banks being forced to keep more money with RBI reducing the funds available for lending. As less money is available to the bank to lend there is bias towards increase in rates as per the normal laws of supply and demand. So an increase in CRR will normally result in an increase in interest rates (and vice versa a reduction in CRR will normally result in a reduction in interest rates).

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The quantum of the increase is at 0.75 % was a tad higher than the market consensus of around 0.50%. RBI has increased the target growth for 2009-10 from 6% to 7.5% for the year, and have clearly indicated that their policies will now shift from ‘managing the crisis’ to ‘managing the recovery’, and thus reverse some of the earlier steps undertaken to provide liquidity in the market. They have also indicated that the “recovery is getting established and inflation fears are coming true”. In fact we can expect more such action including increase in Repo rates, Bank rates Reverse repo rates. (See box for what these rates are and their impact.)

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What is Repo Rate?

The repo rate is the rate at which RBI lends short-term money to banks under a specific secured mechanism. When the liquidity in the markets is high, the RBI increases the rate at which it lends to the banks to make it more expensive for the banks to borrow money from RBI. Thus banks have more expensive money with them to lend to consumers and have in turn to increase their own rates. Thus increase in repo rates have a bearing on other interest rates like your bank FD rates, home loan rates, and so on.

What is Reverse Repo Rate?

It is a mechanism by which banks can park short-term money with RBI. The rate of interest that the bank gets from RBI for such money thus becomes the floor rate for all interest rates at this return is guaranteed to the banks. When this rate goes up naturally the overall interest rate will tend to increase as well.

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How are consumers impacted with these economic moves?

If you strip away the conservative language favoured by all regulators, it clearly means that interest rates are on their way up as far as the regulator is concerned, and hence we will definitely see an increase in overall interest rate during this year. But the quantum of the increase will depend on how inflation shapes up, and that in turn will depend on a host of factors such as demand for credit, monsoon, etc.

Still the question remains how does it affect you and me?

For savers and investors: If you are thinking of depositing monies with banks, then it is advisable not to get into long term deposits. Instead of making a 5 - year deposit you should make a 6/12 month deposit, as it is very likely that when the renewal comes up then you will be in a position to get far better rates.

For new loan consumers:

If we look from a borrower’s perspective, interest rates may not get affected immediately (in the next 45 days or so) but clearly there will be an increase in interest rates the near future. So if you were going to buy a home or a car in the near future, then it makes sense for you to prepone your borrowings immediately and go in for the current teaser rates into the safety of fixed rates for at least 2-3 years. Teaser rates for a year or so are available in car loans as well and customers should look at that also.

For existing loan consumers:

Well if you were smart enough to have taken a teaser loan in the last 6-9 months then just wait and watch since you have already made the right move. But if you have borrowed on a regular floating rate, then you should immediately shift to a teaser rate loan. Do it in next two – three weeks itself before interest rates start to harden or the teaser rate schemes are withdrawn. I repeat – do it now!!! If necessary the shift can be to the same bank from their regular floating rate loan to a teaser rate loan.

Sure the teaser rate loan only secures you for the medium term (the first 2 -3 years)

But it is better than nothing. To quote John Keynes “ ….in the long run all of us are dead….!!!

I had an urgent phone call from my son Akshay about his credit card payment that was due in a couple of days. More about that later. But first let me give some background.

Akshay had the good fortune (or is it misfortune) of growing up with me and the lesson drummed in his head always was that credit cards are a great convenience tool as long as you do not overspend and take care to pay 100% of your dues before the due date. In fact during his college days in Pune (I am based in Mumbai) he had an add-on card (see box for what are add-on cards) issued against my own credit card. The understanding with him always was that this credit card was to be used only for emergencies or for making expenses with my prior approval. However in practise some expenses did creep in on the add-on card (to be fair only on a few occasions), which I paid off as it was billed on my main credit card. What worried me were not the actual expenses as the fact that Akshay was beginning to fall for the allure of the so-called “painless” nature of making payments by credit cards. Being a personal finance expert it became a challenge for me to provide Akshay the experience on the whole cycle from incurring expenses on the credit card to actually paying it off. Given his profile he was not eligible for his own credit card.

It was not until he had completed his studies and had started working in Auroville (near pondicherry) that I hit on the solution. I got him a credit card from Kotak Bank secured against a fixed deposit made with them. Since the credit limit on such cards is around 80-90% of the fixed deposit amount, it is fully secure and Kotak (and other banks that issue such cards like Axis, ICICI, HSBC) is therefore able to issue it to all those who seek such cards. I made the fixed deposit on Akshay’s behalf but the card was in his name. I also made him aware of the charges and interest that he will have to pay if he delays payment even by a single day. Obviously he would have to pay for these charges from the modest stipend he was earning. I also told him about the Credit Bureau (in fact showed him my own CIBIL report) and the impact any delays in making such minor payments would have on the major education loan that he wanted to take after 1-2 years for overseas study.

What are add-on cards?

Card Issuers normally provide a facility to provide additional cards (called add-on) cards to the relatives of the credit card holder. These are issued only at the request of the main cardholder and the liability incurred on these add-on cards is that of the main cardholder. The overall credit limit remains the same and is applied on the main card and all the add-on cards put together. Normally a facility is also provided to the main card holder to restrict the credit limit on a specific add-on card so that he can control which relative is able to use how much of his credit limit. Since the payment of expenses incurred on an add-on card has to made by the main cardholder the add-on card holder does not experience the full cycle of credit card from incurring the expenses to paying off the credit card bill.

Which brings me to the reason for the phone call that Akshay had made to me. Clearly my lessons had worked. The first credit card bill was due in a few days and his card-issuing bank did not have a branch at Auroville. His stipend and the savings that he had from his summer internships were all in another bank and he was worried about how the money was going to be transferred to Kotak in time for the payment. Ultimately we worked out a solution where he withdrew cash from his salary account and deposited it in his Kotak Bank account at Chennai (yes – he actually travelled about 160 kms to Chennai specifically to deposit the cash) and then transferred the money electronically from his Kotak Bank account to his Credit card account with them. Although I could easily have found a solution by depositing the money in his credit card account in Mumbai, I let him sweat it out, as I wanted him to internalise the lesson, which he is unlikely to forget in a hurry.

And what did Akshay think was the moral of the story. In his own words “Credit Cards are like Swiss knives – extremely useful nay indispensable in an emergency – but they need to be handled with care or they can cause serious injuries”.

What a great analogy Akshay.

What do you think? I would welcome your comments as also any of your own stories on how you taught your children the value of using financial tools responsibly.

Amidst all the hype & hoopla surrounding the home loans (teaser loans), there are customers who are still facing the dilemma to remain fixed or to float. They do not want the risk of floating especially when interest rates move upwards, at the same time they do not want high pure fixed rates. They want to avoid the risk, at least for a certain portion of the loan, and some lender’s answer to such an arrangement is known as Hybrid loans.

So what are these Hybrid loans?

It is a combination of fixed and floating, also known as partly fixed and partly floating. Under this scheme, a part of your loan is locked under ‘fixed’ and the rest is under floating – the adjustable rate of interest. In fact it is supposed to be a median option between fixed and floating interest rates. This product works best for the people who are not clear about the rate movements and do not want to take the particular stance. Depending on the risk appetite and risk perception of future rate movements, you have evaluated the pros & cons of both fixed and floating but are unable to come to any conclusion. So, as per the companies, hybrid loan is another option which can work well for customers like you.

In case of hybrid loans, there are two parts to the loan agreements, one for fixed and another for floating.

That means that if you take a loan of Rs. 20 lakh and you feel that interest rates will increase, you can choose to take 60 per cent of Rs. 20 lakh as a fixed rate home loan and the remaining as floating. The proportion can change depending on your risk appetite.

In case rate moves up, you normally have an option of foreclosing your floating component of the loan with no pre-payment penalties. In case you decide to foreclose the loan locked under the fixed portion, standard pre payment penalty will apply unless you have negotiated otherwise.

Normally the company offers an option if interest rates move up, you can get the fixed portion of your floating loan into floating. You can convert the fixed component into floating by paying a conversion fee of 0.5% - 2% or as charged by your bank of the outstanding loan amount.

In the event that interest rates rise, the portion under fixed rate will be your buffer. And if they fall, then you gain on the floating component and lose on the fixed.

This product may work well for people who take large loans because they are more interested in hedging their risks. If instead of the hybrid loan, you decide to go for the fixed interest rate loan, make sure that your loan is indeed fixed for the entire duration of the loan. But lenders mostly put in a clause in some of their loans under which they reserve the right to amend the ‘fixed’ rate in the event of an ‘extreme change in money market conditions’.

Still fixed or floating dilemma has been eased out with the introduction of Teaser loans earlier this year, where interest rates are fixed for certain tenures say three years. After that option lies with you to choose either to chose fixed or floating which is 2.5% below the PLR.

Following suit, many PSU banks have come out with offers where they are offering low attractive fixed rates for the first 3-5 years (8-8.5%) with rates reverting to the standard floating rate after that period is over. These kind of loans are popularly referred to as Teaser loans where rate in the initial years is fixed as well as low. Private players HDFC and ICICI have recently joined the bandwagon. They announced a similar teaser loan product early December, 2009. Thus presenting clearly a good option for the consumers who want to stay away from tracking home loan rates at least for a certain period of time.

So what does a teaser rate home loan mean for the Indian consumer? It means that there is a low initial interest rate that is fixed for a specified period (1 year to 5 years) and the floating rate as specified becomes applicable thereafter.

Given below is an analysis of the some of the teaser rates home loans available in the market for a 20 year home loan of Rs. 30 lacs.

Home Loan interest rates for 20 years, Loan amount of Rs.30 Lakh - as on December 23, 2009

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BANK For first year Overall effective rate

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SBI Easy Home Loan **** 8 8.76

CANARA BANK *** 8 9.33

HDFC** 8.25 8.63

ICICI BANK * 8.25 9

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****SBI offers 8% fixed for the 1st yr, 8.5% fixed for the next 2 yrs, 4th yr onwards borrower has an option of choosing either floating rate which will be 2.75% below SBAR or fixed rate which will be 1.25% below SBAR. *** Canara Bank offers 8% fixed for 1 yr, 9% fixed for next 4 yrs, thereafter min. 10% for loans upto Rs 30 lakh.

**8.25% fixed till 31st March 2012, thereafter prevailing floating rate (currently 8.75%)

*8.25% fixed for 2 years , 3^rd onwards it is FRR (currently 12.75%) minus 3.50% = 12.75% -3.50% -= 9.25%

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But it is certainly not a one time decision, you need to review your decision at fixed intervals. Basically, partly fixed and partly floating interest rate loan lack interest rate transparency. The so-called fixed portion may be varied and there is no objective mechanism to ensure that floating rate floats down.

Mixed rates are normally not recommended mainly because of the non-transparency of the banks on both these (fixed & floating) rates. The risks are there even if you opt for pure fixed or pure floating, still you are not exposed to dual opaqueness.

It is advisable to use online home-loan calculators on sites like www.apnapaisa.com to estimate the Estimated Monthly Installments (EMI) for the loan amount you require. You will also need to understand the difference between Fixed-rate, floating-rate, the teaser rates or the combo (hybrid) rates to determine the rate type that is best suited for you.

Hence, it is important to evaluate all the pros & cons before making a decision in favour of hybrid loans.

After initially playing down the teaser home loan product first introduced by SBI in January 2009 , market leader HDFC has decided to join the bandwagon. They announced a similar teaser loan product on December 1, 2009. ICICI bank announced its own teaser plan on the weekend. This clearly is a good time to be a new home loan customer.

So what does a teaser rate home loan mean for the Indian consumer. It means that there is a low initial interest rate that is fixed for a specified period (1 year to 5 years) and the floating rate as specified becomes applicable thereafter.

Given below is an analysis of the some of the teaser rates home loans available in the market for a 20 year home loan of Rs. 30 lacs.

Source : Apnapaisa Research Bureau

Effective rates have been worked out assuming the floating rates will be what they are today.

*HDFC effective rate worked out assuming lower teaser rates are applicable for 24 months.

HDFC and ICICI bank’s dual home loan rates are now in competition with SBI’s Easy Home Loan scheme which offers competitive rates at least for the first three years.

Do teaser loans make more sense then regular floating rate products?

Interest rates are thought to have bottomed out and are widely expected to go up next year and these teaser loans provide a cushion at least for the next few years. After teaser period is over, if your lender does not offer you market determined floating rates, you should switch your loan to another lender. The effective rate of these teaser loans are also fairly good and hence it should clearly be preferred over regular floating rate loans which might increase rates next year itself based on current market conditions.

So what should a consumer look at while choosing a lender based only on teaser rates?

The big variable in most cases is the applicable floating rates after the initial period of fixed rates is over. In working out the effective rates it has been assumed that the floating rates will be what they are today. This may not necessarily be true as different banks may follow different strategies on floating rates at that time. One should not forget the story of people who had gone in for a similar teaser rate home loan scheme floated by a foreign bank in October 2003 with interest rate of 6% for 1^st year and 6.50% for 2^nd year (against the then prevailing floating and fixed rates of 7% and 7.50% respectively) and floating rates thereafter. By the time the two year teaser period was over, the bank had lost interest in the home loan market and interest rates were jacked up to double digit levels even as the prevailing interest rates were still around 8.5 –9.50 %. As a result a lot of consumers were forced to switch their loans to other lenders. It is in this context that the PSU banks are likely to score over their private sector counterparts. The report of the working group on Benchmark Prime Lending rate appointed by the RBI to look into introducing transparency in fixation of floating rates by the banks has remarked that “ An increase in the repo rates was observed to bring about a contemporaneous change in modal BPRLs of the private sector banks and major foreign banks and a lagged response in the case of the public sector banks. A decrease in the repo rate had a significant contemporaneous impact only in the case of the public sector banks”. In simple English what the group’s research showed was that the PSU banks were slow to raise floating rates for existing customers when repo rates rose and were quick to drop rates for existing customers when the repo rates dropped. Off course the fixation of floating rates will hopefully be a little more transparent in the next few years but if doesnot home loan borrowers from PSU banks will hopefully not be required to make the effort to switch lenders.

The other issue is that people should also look at pre-payment charges and any upfront charges (processing fees/stamp duty/legal charges, etc.).

But perhaps the most important thing is the property itself. If you are buying an old property (greater than 25 years) or a resale property that has gone through many owners or an under construction property that is still in the initial stages of construction then it might be useful to consider the private lenders simply because they have developed expertise on dealing with the issues arising from such transactions.

Can existing home loan consumers take advantage of these schemes?

On paper all the banks (including PSU Banks) that offer these teaser products are offering it only to these new customers and not to their existing customers. So if you are an existing loan customer of any of these lenders and want to take advantage of these schemes, you should switch your loan to another lender (i.e. become a new customer to that lender). All the lenders offer the teaser rate products to existing home loan customers of other banks. Ironic but it is not available to their own customers.

So ‘Teasers’ do make a difference in the lives of new customers as well as existing customers.

“Should I let my son go for an MBA overseas?”

This innocuous little question on Apnapaisa “Ask the expert” section caught my attention.

Why this question?

Which father would not want to let his son do an MBA overseas? I questioned myself.

To look answers for our ( His & Mine) questions, I decided to dig a little further to find out what was the dilemma about.

Let me share the dilemma and the solution here:

The reader Dinesh Sehgal (name changed) was in his early 50s and was working as a mid-level officer in a Public Sector Undertaking (PSU) in Delhi. He had married off his two daughters and his only son was an engineer and working with a Delhi based Software Company. The expenses incurred on bringing up his children and their education and marriage and his own modest income (Rs. 7 lacs per annum net of taxes) meant that he had no significant investments/savings. He had his own house (worth around Rs. 55 lacs) though with a home loan of Rs. 18 lacs still outstanding on it. His son wanted to do an MBA in Australia, which would cost him around Rs. 20 lacs. His son had savings of around Rs. 5 lacs and was looking for an education loan of around Rs. 15 lacs. A PSU bank had also agreed to provide this loan but required Dinesh to be a guarantor as well as to provide the house as a collateral security for the education loan. The PSU bank was prepared to take over the existing home loan as well from the existing lender.

If it was all set, then what was the problem?

Clearly Dinesh was having second thoughts. His only serious asset was the house and he was worried about loosing his house in case the son was not able to repay the loan for any reason. An unstated concern was perhaps whether his son would be responsible enough to pay of the education loan or leave him holding the can after completing the course and starting of his career. At the same time he badly wanted his son to get the additional qualifications so that he could progress in his career.

A real dilemma, this!

Even this left me perplexed, like what to advice him? As a fellow Indian I understood Dinesh’s desire to do the best for his son. At the same time as a Financial Planning professional it was clearly not advisable to expose your only financial asset to the risk in such a manner.

I must confess, I was a bit confused. After lot of discussions with our financial planning team (all of whom are much younger – with only one of them having a child aged 7 years - and hence not really in a position to empathise with Dinesh’s dilemma) I gave worked out a typical Indian style compromise solution.

My first question to Dinesh – Are you prepared to borrow money against the security of your house to lend to your son for the purpose of his higher education?

His reply was, “ If I could be reasonably sure that my son would pay it back.”

My next question - Under what circumstances did you expect your son not to repay the loan?

He mentioned the following reasons:

1) He will fail in the course – given his brilliant academic track record so far this was unlikely

2) He will fall sick or have an accident preventing him from completing the course – this is an insurable risk and should be covered by Insurance

3) He will complete the course but not be able to get a job – given his background this position at worst can only be temporary

4) He will get a job but due to other responsibilities (marriage, job overseas, etc…) neglect to repay this liability.

The last point was the real concern area. Normally, I told Dinesh, you depend on our culture and traditions to make sure that the son will pay for the father’s debts. (read the story in DNA dated November 21).

Analysing his state of mind, I advised that in your case the debt was really taken by your son himself and only guaranteed by you. A good compromise option would be to draw up a legal document between you and your son making it clear that whilst both are joint borrowers on the bank’s records, the loan has been taken for the purpose of the son and as between themselves he is fully liable to repay the loan. This document along with the normal social pressure that exists in our society should be a reasonable safeguard against the son neglecting to pay back the education loan even though being capable of paying of.

Dinesh has not got back to me on this and I am not aware whether he actually followed my advice. Could there have been a better advice in such a situation?

I invite the views of all you readers on Dinesh’s dilemma.

“ My father aged 69 years was retired and staying with me. He had a credit card since the last 15 years. He expired last year in October and since January this year I have been harassed by phone calls from the bank claiming that there is an outstanding of Rs. 32,000 on his card. Now they want me to pay this outstanding. Is it legal for the bank to demand the dues of the father from his son? What should I do? - Rajesh Batra, Gurgaon*.

As soon as I saw this query on our Ask the expert section of Apnapaisa, the memory of late Bollywood actor Kanhaiyalal (who played money lender Sukhi Lala in Mother India) flashed in mind…Circa 1959.

Here was the new age Sukhi Lala (Circa 2009) who is passing the debt baton from one generation to another…till now I thought that times had changed. The tradition of passing the debt from one generation to another was long dead say since independence.

I always felt that Sukhi Lala - the villainous moneylender in old Hindi films – notably Mother India – extracting money from sons for loans taken by their father was more a caricature than the truth. But here was Rajesh with exactly the same dilemma in 2009.

To rescue people like Rajesh, I consulted a few legal expert friends who gave me the low-down on this:

1) First they corrected me about the “Mother India” analogy. In Mother India the father (played by “Jaani” Raj Kumar) had mortgaged his farmland for taking the loan. Hence the repayment was forced from the heroine (the incomparable Nargis) and her two sons because they were emotionally attached to that land and wanted it to be released from the moneylender’s clutches. If they had refused to pay, the moneylender could have proceeded to take possession of the property and sell it to recover his dues along with interest (at a draconian rate). In the case of Rajesh’s father, it was an unsecured loan, hence clearly this was not applicable.

2) Second the bank only had the ability to proceed against the estate of the deceased. So Rajesh would be liable for the credit card debt only if he had inherited something from his father and that too, up to the value of what he had inherited.

Acting in accordance, I wrote to Rajesh to check if he had inherited anything from his father. He mentioned that he only inherited some personal stuff (such as a ancient copy of Ramayan that his father had nurtured his entire adult life) with almost nil economic value. We told him to write to the bank giving all these details and if they still persisted to file a complaint with both the RBI as well as the police for undue harassment. My lawyer friend also advised him that he would have a good case for damages against the bank if they persisted in trying to recover the money even after they had been advised about the facts in this case.

Rajesh accepted the advice and wrote to the bank. Post that the recovery calls from the bank stopped.

However the story had an unexpected ending. Rajesh checked with me whether his fathers name would show up as a defaulter in the Credit Bureau’s records. I informed him that I was not sure of how the bureau dealt with records of people known to be deceased but it was most likely that his father’s record will show up as a default for the next 7 years. This was not acceptable to Rajesh as he said that his dead father had led a blameless life and had never defaulted in his entire life. Rajesh said that he would settle up with the bank to ensure that his dead father’s name was not sullied anywhere. Last I heard he was in the process of settling the bank’s dues to get the name of his father cleared.

For me this was an extra ordinary ending as it highlighted not just Rajesh’s love for the memory of his dead father but also the efficacy of the newly established credit bureau to bring down the overall outstandings in the retail lending scenario.

Hail the spirit & concern of people like Rajesh!

* Name changed to protect the identity.

Last Friday my friend Hemant Mishra approached me with a problem, which may sound mundane, but it caused lot of trauma to my friend, courtesy insurance company.

Acting on my advice, he bought a term insurance policy as I always thought it was important even though he had an impressive profile – age 42, decent income, good savings, low debt, high placed professional in an MNC bank and to top it all a fitness buff. Based on this I had recommended him an amount which ran into crores as sum assured.

So I was surprised on receiving a call when an anxious Hemant who told me that there was a problem with respect to his term insurance policy.

Let me share Hemant’s account with you.

His Insurance agent had started the process under which made Hemant filled up the form, paid the premium followed by a battery of medical tests. Given the size of the policy, he had to answer quite a few questions from the Insurance company, besides visit to his office by insurance company’s personnel. The process was smoothly completed and it was time for him to receive the policy. Here comes the real shocker, when the insurance company informed Hemant that they would be charging an extra premium. Reason? quipped Hemant. He was informed that there were some issues with his medical reports, hence he would be required to pay extra charge to get the policy and insurance company wanted his approval in the matter.

At this point Hemant was more anxious to know what were these exact health related issues. Now comes the real twist. When he asked for his medical reports from the insurance company, he was informed that his medical reports were their property and cannot be divulged. He was aghast at this response

Now he was far more anxious to know about the health related issue in his medical report rather than the insurance policy itself.

When he mentioned this to me, I made the research team at ApnaPaisa to do a quick check on the practices followed by the various Insurance companies in disclosing the medical reports to the insured person. They informed that most companies will provide a photocopy of the medical reports on request to the consumer, whereas one . insurance company was willing to provide the copies only to the family doctor named in the Insurance proposal form. But the company chosen by my friend was an exception which did not provide the reports to the insured at all.

A quick check on the Insurance Act showed that Section 51 of the Insurance Act, 1938 requires that Insurance company should supply the “Policy Holder” the medical reports.

So legally speaking Hemant was entitled to a copy of all his medical report after paying a princely sum of Re. One, Once he became a policy holder which means he paid the extra premium and took the policy. After he got his policy he would be in a position to get the medical reports.

In case the Company still refused to give him the medical report, he could file an official complaint on the Insurance company’s website. In case that did not elicit any response he would have no choice but to file a complaint with the Insurance ombudsman or the alternative grievance redressal mechanism of IRDA (details on www.irdaindia.org).

By this time Hemant ( and his wife) were frantic with worry and so decided to repeat all the tests at his cost as he did not want to wait for the Insurance company to react to his request. I asked them not to worry too much as it was very unlikely that there would be anything seriously wrong in his report. Otherwise the Insurance company (or its re-insurers) would have clearly declined to issue the policy rather than just charged an extra premium. I asked him to follow up with the Insurance company after he took the policy since those reports would also serve as a very useful checking point against any reports that he would obtain on his own.

It is indeed sad that Hemant had to go through this distressing experience due to the policies of that specific insurance company.

Let’s hope other consumers are spared such an experience in the future.

The regulator (RBI) has been concerned about making credit pricing more transparent for quite some time now. One of the reasons being the wide spread complaints by home loan consumers that lenders are quick to raise BPLR when the regulator raises signalling rates (Bank rate, Repo rate, Reverse Repo rate or other rates such as CRR and SLR) but lag behind considerably when the regulator drops these rates. 

The working group constituted by the regulator for this purpose has submitted its report and RBI’s final decision is awaited. This article seeks to examine if the “Base Rate” system recommended by the group is more transparent than the existing BPLR system.

The short answer to that question is “Of course – Yes”. The Base rate system is definitely more transparent than the existing BPLR system. But there are some non-transparent aspects to the fixation of the Base Rate, which needs to be highlighted. 

In simple words the “Base Rate” system recommends that the 1-year retail fixed deposit rate of a bank (after making certain adjustments) be the Base Rate for that bank and that the floating rate loans be pegged with reference to such a Base Rate. The 1-year retail fixed deposit rate for a specific bank is easily and publicly available and to that much extent it adds considerably to transparency. It is the adjustments, however, that are based on not so easily available information as well as complex to calculate. For the adjustments the consumers will still need to depend on the concerned bank to make them properly. Having said that any bank will find it really tough to explain why the Base rate has not dropped if it decides to drop its 1-year retail fixed deposit rate.

Some other issues with this mechanism also need mention.

First, not a single bank follows the existing regulations requiring floating rate loans to be priced with reference to a suitable external benchmark. In fact, if this regulation is followed there is no need for any change in the regulation at all. This leads to justifiable concern among consumers whether any new regulations will be followed by the banks or whether the regulator will enforce any regulations that it chooses to notify in this regard.

Second, the group has left vague the applicability of the new Base system to existing borrowers by stating “ …if the existing borrowers want to switch to the new system before the expiry of the existing contracts, in such cases the new/revised rate structure should be mutually agreed upon by the bank and the borrower.” Here everybody will agree that it is nearly impossible for a single borrower to get the bank to agree on something like this. It would have been better if the modalities of applying the new system to the existing borrowers had been spelt out clearly.

Third, of course is the enforceability of any new regulations. Any regulations to be effective needs to be monitored by the regulator and transgressions need to be penalised and repeat offenders need to be punished.

Let’s therefore hope that if the regulator chooses to accept the group’s recommendation then it will also be enforced vigorously.

Amen!