The biggest complaint of loan consumers in India who have taken loans on a floating rate has been that lenders are quick to raise rates for them when interest rates rise in the market but are very reluctant to reduce their interest rates when market interest rates drop. Till June 30, 2010 the floating rate products were priced with reference to their Benchmark Prime Lending Rate (BPLR). Clearly the BPLR system was not functioning in a transparent manner. After setting up a committee to examine the issue and a draft note inviting public suggestions the guidelines relating to the new “Base Rate” system have been made effective for all loans issued or renewed on or after July 1, 2010. So will this new Base Rate system be effective?

This article examines the difference between BPLR and Base Rate regime and the potential impact of the Base Rate system.

The rate is “to be computed taking into consideration (i) cost of funds; (ii) operational expenses; and (ii) a minimum margin to cover regulatory requirements of provisioning and capital charge, and profit margin”. No this RBI pronouncement is not about the Base Rate but about the Benchmark PLR. If you see the non-binding “illustrative methodology” for the Computation of the Base Rate in the guidelines, it also more or less lays out the same set of parameters but just in greater detail.

So if the calculation method is similar how will Base Rate system make a significant difference?

For starters there are two big differences. Whilst each bank can choose its own benchmark for the cost of funds they will have to document the detailed formula for the calculation of the “Base Rate” and the method of calculation and follow it consistently (except during a brief six month transition period). This formula will need to be disclosed to RBI, which can also scrutinize that it is being followed consistently. This is unlike the BPLR regime where the BPLR was supposed to take into account the same set of parameters but no documentation was required and it was not open to RBI scrutiny. This is a significant difference between the two regimes since this forces the banks to follow a consistent method of calculating the Base Rate unlike the BPLR.

The second big difference is that, unlike the BPLR, banks are not allowed to lend below the Base Rate (again there are a few exceptions but they are not very relevant for this purpose). Now we all know that blue chip corporates are always able to get good rates from the banks. They are likely to be borrowing at interest rates very close to the banks’ current Base Rates. When market interest rates fall they will naturally expect to get better rates and naturally the banks will be forced to drop their Base Rates if they still want to maintain their share of this market. So apart from the point mentioned in the first paragraph, this factor will also exert downward pressure on the Base Rate when market interest rates fall.

If the transparency is so built in then why the doubt on whether the Base Rate system will be effective or not? Clearly the Base rate system is designed to be more transparent than BPLR. But unfortunately there is no requirement that the detailed formula of each bank’s Base Rate be made public (it is only to be available for review and scrutiny by RBI). Clearly RBI will need to set up a machinery to monitor and review these calculations to ensure that they are consistent, which given their focus on ensuring transparency is likely to function as an effective check on the proper implementation of the Base Rate system. It would be very interesting to find out whether the general public under RTI can access a specific bank’s calculation of Base Rate that is available with RBI.

As is likely the effective functioning of the Base Rate regime will significantly change the retail lending industry in India. Firstly as changes in the effective interest rate for the customer will depend on the “average” cost of funds rather than the “marginal” cost of funds any increases in market rates will take time before they are fully passed on to the borrower (see box for difference between “average” and “marginal” cost of funds). Whilst this is beneficial when interest rates increase it is also not so bad when interest rates decrease as, unlike the current situation, the consumer is likely to get some decrease immediately compared to none or very little in the current scenario.

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Difference between average and marginal cost of funds

Assume a bank currently has funds of Rs. 100 crores at an average cost of 10% (total cost of funds is Rs. 10 crores or Rs. 2.50 crores per quarter). Now the cost of funds in the market goes up by 1% pa. On an arithmetic basis the banks cost of funds should go up by Rs. 1 crore per annum or Rs. 25 lacs per quarter. However since a lot of the bank’s funds are in time deposits which are at a fixed cost - where the cost will rise only when the deposit comes up for renewal - immediately its cost may go up by only say 12.50 lacs for this quarter or only 0.50% p.a. Of course over a period of time as all the fixed deposits mature and are renewed at new higher rates the cost of funds will go up to Rs. 11 crore per annum or 2.75 crores per quarter). Thus the average cost -10% in this example changing to 10.50% or a change of 0.50% only - will always change slower than the marginal cost - +1% in this example)

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If you have an existing loan should you shift to the new Base rate regime?

Firstly there is no automatic shift to the new regime. You will have to ask your bank to shift you to the new Base rate regime for which they are not supposed to charge you any fees. If you are on an existing fixed rate loans (or in the teaser period where rates are still fixed) where the rate is lower than the current floating rate of 8.50% - 9% than wait till you are on a floating rate basis for shifting to the new regime. If you are paying interest rate in double digits then shift to the new regime immediately. If your existing lender is not giving you good terms for the shift or is not acting fast enough to shift you to the new regime then you should seriously consider shifting to a new lender altogether)

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The National Housing Bank (NHB) which regulates the housing finance companies – HDFC, LIC Housing Finance, etc.- will also be forced to come out with a similar system for HFCs which will be good for the home loan consumers. Similarly the scheme will have to be extended to NBFCs also by RBI though that is likely to have a smaller impact on the loan consumers.

In any case the impact of this fundamental change will be felt only over a period of time – at least 6-12 months as interest rates change (likely to increase) during that period. Here’s hoping that this change has a fundamental impact on all loan consumers.

The modern day consumer is in a perplexed state owning to the multiple loans he has to service for fulfilling his various needs/ wants.

So are these loans bad or bad?

Loans, probably being my ‘middle’ name, this question coming from me may surprise many as I have been advising consumers on various facets of loans for many years on a day-to-day basis. Here I would like to draw a parallel from Bollywood movie Dayawan where film ends with a question by child character – Was Dayawan (the protagonist who plays a mafia don with a heart of gold) a good person or a bad person?

So it depends on your perception.

They are good if you are able to manage and balance your loan portfolio, besides having a good repayment capacity. But it becomes a messy affair if they are not managed well or your repayment capacity takes a beating.

Ideally loans should be a means of creating assets or enhancing earning capacity. Then they are also a means to attend to unexpected emergencies. They are a “must” whatever situation you are in but the purpose of the loan plays a crucial deciding factor. The other deciding factor is the cost of the loan. The purpose of loan must also be cost effective. As you need loan to fulfill the need for more than one asset at a time, it is very important to priorities your loans.

If you are undertaking “hair cutting” course for Rs. 20 Lacs, it may not be worthwhile, as the earning capacity may not be enhanced that much. Even when the loan is for a good purpose say paying the fee for an educational course that will substantially add to the earning capacity but if the cost of the loan is too high, then it will not remain a good loan.

At the top of the hierarchy most loans taken to fund education for self or a family member would normally qualify to be a “good” loan as they create substantial earning capacity relative to their cost and are normally available at a reasonable interest cost. Tax breaks on the interest would also reduce the post tax of the loan substantially.

Second would be loan taken to fund a reasonable cost house for your own residence. Normally this asset price appreciates in value and will also act as a source of pension income or retirement through the medium of a reverse mortgage. Third would be a loan taken to buy your own reasonably priced vehicle (two-wheeler or four-wheeler). This may result in a boost in your productivity given that public transport in most cities in India is quite poor.

Then there are loans taken for consumption such as for funding or an expensive/ luxury consumer durable.

Basically there are two types of loans - Secured loans are loans such as home loan and vehicle loans. They are backed by your assets in order to minimise the risk assumed by the lender. The assets may be forfeited in case there is a failure to make the necessary payments.

Whereas unsecured loans are personal loans and credit cards, where the lender has no entitlement to any of the borrower’s assets in case borrowers fail to repay the loan. Such a loan normally carries a higher interest rate than a secured loan. Repayment plans of loans vary based on each type of loans. Home loan repayment plans can be as high as 20 years or more, whereas vehicle loans can be repaid in 3, 5 or 10 years, and the credit period for credit cards is around 50 days.

The consumerism boom fuelled by the presence of modern places of worship – Malls, has led to the phenomenal growth of plastic money. Swipe…swipe…swipe is the new mantra chanted by one and all. And the prasad of this mantra is debt…debt…and more debt. The debt on the credit card for longer duration will land you in a financial mess. The borrowing on credit card should not exceed 30 – 45 days, as interest charged is very high on such credit.

Last would be loan taken for speculative purpose such as investments in stock markets. These are strict No-No.

I would like to quote Benjamin Franklin here: “Remember, credit is real money,” which we tend to forget.

Thus it is important that you make it your personal goal to pay your credit on time as it will impact your credit rating.

So to end – remember loans can be very useful – nay – essential to improve the quality of your life and your future generations. At the same time it has the potential to destroy your life if used unwisely.

A momentous moment in India’s retail lending history has just been ushered in very quietly. A few days ago Credit Information Bureau of India Limited (CIBIL), which is currently the only fully operational credit bureau in India, quietly introduced a manual system to provide consumers with their own credit history on a test basis. In a written communication from CIBIL to Apnapaisa it has been clarified by CIBIL that “CIBIL has started offering Consumer disclosures through an interim solution. This interim solution is a testing phase and we will be able to operationalize the full-fledged Consumer Relations System basis our learning from this phase. In this interim phase CIBIL will be manually handling consumer requests for a copy of their credit information report.  CIBIL is also developing the infrastructure, systems and processes for an automated solution that would be needed to enable an individual direct access to their Credit Reports from CIBIL on-line.  The full-fledged Consumer Relations System will have world-class features that will allow consumers to access their report on-line and banks to respond to errors via an on-line maintenance tool. The automated phase is expected to be ready by the beginning of next fiscal year “.

So why is this such an important event that I am calling it a momentous occasion for the Indian retail lending history. For those of you who have just tuned in, CIBIL is one among 4 credit bureaus that have been licensed by the RBI under the Credit Information Companies Regulations Act, 2005 (CICRA). CIBIL though is the only one that already been operational for around a decade now and has the credit repayment history of around 13.7 crore loans or credit cards.

Almost all of the major lenders provide details of the credit facilities given by them to their customers as well as the amounts that have fallen due and the repayment made by the customers on a periodical basis (monthly or quarterly). CIBIL collates and aggregates this information. Thus when a customer (say Mr. Desai) approaches any bank (say Bank of Bharat) for a credit facility CIBIL is in a position to go through its own records and provide details of the existing credit facilities enjoyed by Mr. Desai to Bank of Bharat as well as his repayment history on such facilities. This enables Bank of Bharat to take a more informed decision on Mr. Desai’s credit application since it now has access to credible third party information on Mr. Desai’s existing obligations as well as his repayment history. It also benefits Mr. Desai if he has maintained a spotless repayment history since he is able to get the credit facility quickly and cheaper based on such good record. If his earlier repayment history is not so good, off course, he will find it difficult (and more expensive) to get the credit facility.

Up to now Mr. Desai could not access his own credit report. There was a rather convoluted way for Mr. Desai to get a copy of his own credit report but with this step he can get a copy of his own report by paying Rs. 142/- to CIBIL. This will help him in finding out if there are any errors in the report. A large number of consumers today feel helpless about erroneous repayment history being reported by the banks to CIBIL showing the consumer in default even where the so called “outstanding payment” is in dispute. These kinds of errors are the highest in the case of credit cards.

Since now he can have access to his own report the consumer can point out any errors in the report to CIBIL who are, under the CICR Act, required to notify the concerned bank. The erroneous entry will have to be deleted by CIBIL unless the concerned bank reverts to CIBIL within 30 days of the consumer filing his error report with CIBIL. If the consumer is not satisfied with the action of the bank in this regard he can always file a grievance before the banking ombudsman. Thus by having access to their own credit report the good consumers can ensure that they do not fall victim to erroneous reporting by the banks. At the same time consumers who delay payment for any reason will have to pay the price for such delays. Good consumers who pay their instalments will stop subsidising the consumers who delay payments. At a future point of time CIBIL may even share their proprietary credit score with the consumers for an additional fee. This score predicts customer’s likelihood of becoming a defaulter in more than 91 days within the next year. Higher the score less are the chances that the consumer will default. Any score above 700 is considered good. Having access to this score will assist the consumer in getting a rough idea of how banks view his credit standing and he can then take action either improve his credit score or if his score is already very good take care to maintain it at a high level.

So if you want to get a copy of your own credit report download the form available on the apnapaisa website at this link and fill it in and along with the required documents (mentioned in the form) and the payment of Rs. 142/- send it off to CIBIL address mentioned in the form.

This historic step needs to be welcomed with all fervour by consumers who will now no longer be helpless in knowing what banks are reporting about them to CIBIL.

I have already sent in my application to get a copy of my credit report.  I have taken great personal care to keep my credit standing immaculate but am awaiting with bated breath what my credit standing looks like as reported by the banks.

Watch this space for my comments on my own credit report.

Budgeting for a car is as important as budgeting for any other activity. Here are some pointers that will come handy when you decide to buy a car, old or new.

The first step is to work out your expenses; and then the savings. Check how much you can save up for your car. When you buy a car, there are many costs that come along with it. Keep a margin in your calculations to meet costs such as fuel bills, insurance premiums, and servicing.

Set a budget and stick to it. Ignore all that the dealers or the finance company has to say. Especially, if they say that you can afford more. And, there is NOTHING such as a ‘zero per cent’ loan.

Assess whether you need a brand-new car or if an old machine will do as fine. Depreciation is a major chunk of the cost of owning a car. Even if your car is just a year old, there is a hefty amount to be lost should you sell it. This essentially means that you can buy an old car on the cheap. If old is as good as new, why empty your pockets? Remember, buying a car as an investment option may not really work. Registration costs, insurance, maintenance; such costs can’t be recovered if you were to sell the vehicle.

While it is advisable to buy a house on loan, a loan should be the last resort to buy a car. Save up on cash to buy the car. Car financing can be expensive. And, no tax benefit on the loan unless you lease it out. Buying a car outright can get you discounts.

If you are looking for a loan to finance your car purchase; shop for a loan first. While a housing loan lays emphasis on the actual property, buying a car via a loan lays primary emphasis on the finance options available. Arrange for the down payment. DO NOT go the personal loan or loan against security route to get the cash.

Once you have checked out your finance options, assess your car. New or old, ascertain the one you need. Assess the purpose - whether you want to rent it or use it for personal needs.

An important step of budgeting is to get an estimate of the price. Do your homework and set a target price. Use all the channels available. The Internet being the quickest, visit as many dealers and agents as possible to get estimates.

Make negotiations before you purchase. Don’t let the dealer eat up your savings. Don’t take discounts as they are. Make sure the offers are indeed discounts, not future expenses hidden away inside them.

Increasing costs of steel and other such inputs have already led to an increase in car prices. Add to that the sky-rocketing fuel prices and owning a car becomes bloody expensive.
What about those who already own a car, especially the ones who have bought them on loans? Rising interest rates have had a greater impact on these borrowers in terms of the increase in EMIs. The slack in the job markets, stop on salary increases…mounting pressures of inflation on expenditure… All these mean that a lot of borrowers are moving from being car owners to car loan defaulters.
Wait, this isn’t over.
Banks seem to be taking to tougher recovery measures. On the other hand, the Supreme Court extended the deadline on repossessing and selling defaulters’ cars to three months from the erstwhile 24 hours deadline.
These developments have had a two-pronged impact on the sector: lenders have made lending norms stricter and old car prices have dropped.
Finally the good news - old car prices have dropped by 15 to 25 per cent. About a quarter of the cars in this market are repossessed cars. Borrowers who can get a loan can get good cars at cut rates. They could also vie for a luxury car as these prices will see steeper falls.

Question: Can you afford to purchase a new car?
Another question: if you can indeed afford it, how much exactly can you afford? Which, in turn, pops up another question - What can you afford to pay per month?

Okay, answers now.

The first step is to assess your personal budget and determine what you can afford a month. There are many personal budgeting guides out there that will give you an idea of how much spare money you have each month. As a general rule of thumb, you should track every paisa you spend over a period of at least a month. This will help determine where you really spend your money and how much you can afford. Take into consideration all basic necessities and set aside a certain portion for contingencies. You might be actually surprised to learn exactly where your money is going each month. And make slight adjustments to your spending patterns to ensure that you have a respectable amount that you can set aside.

Now work backwards from here.
Let’s assume that you can afford to pay Rs.10000 a month for that new car. Taking into calculation current interest rates offered on car loans, you can now calculate how much you can borrow.

If you can afford an EMI of Rs.10000, at an interest rate of 14% per annum for a 60-month loan, you are eligible for a loan of Rs. 4.29 lakh approximately.

You now know your upper limit for the car loan. If your EMI outlay per month is around 30-40% of your net take-home pay, you are home and dry. You can have that car and the cost will not play havoc with your monthly budget.

The above tips will help you to get an idea of the new car that you can afford. Loan amounts disbursed are totally at the discretion of the lender. If you have good credit history, lenders could finance 100% of the car cost. Typically, you need to put up 10-15% of the cost of the car. In the above-mentioned scenario that would work to around Rs. 75000. Add this to the loan amount and the car you can afford is really over Rs. 5 lakh!

The author is a Relationship Manager working with the Mumbai-based SRE Financial Planners.