RBEye: Red-eyed RBI wants lenders to revisit interest rate policies

-Vinod Kothari (vinod@vinodkothari.com)

Against the backdrop the action against 4 specific lender, RBI now expects all NBFCs to appraise their boards of the action taken by the regulator, and in specific terms, have the interest rate policy examined with respect to, at least, the following, in “unambiguous terms”:

• The Board of each NBFC shall adopt an interest rate model taking into account relevant factors such as cost of funds, margin and risk premium and determine the rate of interest to be charged for loans and advances
• The rate of interest must be annualised rate so that the borrower is aware of the exact rates that would be charged to the account.

Usually, it is believed that if a penal or disciplinary action is taken against some, it is in relation to aberrations by the respective entities. While others need to sit up and take notice it is but natural, but it is a bit different this time – the regulator itself is expecting that all NBFCs need to sensitise their boards on the action taken. The action taken by the RBI is hardly a surprise and therefore, all boards of all NBFCs know it for sure – however, what is not known is what was the background for the action taken. Generic expressions such as “fair, reasonable and transparent pricing, especially for small value loans” have been used in the press release, but these have always been there and have always been the abstractions that everyone talks about, and tried to walk. But what boards of every NBFC will need to know is the nature of the aberrations. Other than just expressing concerns and sending alert signals, NBFCs may need to do self introspection and course correction, for which they would have expected granular observations, as in the case of gold lending vide circular dated September 30, 2024. 

It may be the expectation of the regulator that interest rate models, based on which the actual setting of interest rates by business is done, are not vague or subjective, and leave room for opportunistic pricing. For example, the risk premium on loan is imposed on the price: this should be a reflection of the expected loss models. There may be loan acquisition costs and servicing costs – which may be either fixed, variable or semi variable. These may be translated into a mark-up based on appropriate pricing models. The most important component of loan pricing, of course, is the cost of capital – including the cost of equity, which may be priced on the basis of actual (in case of equity, expected) costs of each of the sources of capital. In essence, there is entity-wide or product-wide pricing, such as cost of capital and servicing, and loan-specific pricing, such as cost of acquisition and credit risk premium.

These models may be granularly put before the Boards of NBFCs. Boards do not get into pricing, but with the kind of shocks that RBI has given to some lenders, boardrooms rather get into details of pricing being charged.

Another very important factor in pricing are the “extras”, which have become increasingly important over time. These may be fees that NBFCs get from allied services, or subventions from vendors, etc. These constitute part of the returns, but are not shown as cost to the borrower. These may also eventually be a matter of concern. 

Vinod Kothari Consultants did a webinar recently on the RBI crackdown – here is the link to the recording of the webinar: https://youtu.be/poy6_HehPgU?feature=shared.

Other related resources:

1. Is half-truth a lie: Hidden Costs in zero-interest loans
2. Fair Lending: RBI bars several practices
3. FAQs on Penal Charges in Loan Accounts