At Yahoo: Innovations and Curses

At Yahoo, I write about Innovations and Curses:

In the last 10 years, India has grown at a rate that defies belief. Yet, the rate of growth and the dramatic increase in technology that accompanies it has come with certain curses — the side-effects of what has been a fantastic decade for India.

Curse #1: Floating Rates, Pre-closure charges, Teaser-rates

Home loans have, in the past, been sold as fixed rate loans where you pay a fixed rate of interest for the tenure of the loan. For about seven years now, banks have been pushing floating rate loans hard — where interest rates change according to the bank's lending rates. Now floating rate loans aren't necessarily bad; because banks borrow short-term (1-3 years, through deposits) and lend long term, when short-term interest rates go up, fixed rate loans hurt the bank since they get only that much interest but have to pay out more. Floating rate loans gives them the ability to adjust both lending and borrowing rates.

Unfortunately, the practice is now a curse — to squeeze the maximum out of customers, banks have only raised rates at the drop of a hat. When interest rates fell, banks refused to cut lending rates — which made the concept of "floating" more like a one-way street, in favour of the banks. Another trick was to create different internal "benchmark" lending rates — so new customers were offered loans that floated with a lower benchmark rate to attract new business, but existing customers were linked to a higher different benchmark rate. The RBI has recently tried to curb this practice by making fresh loans linked to only one rate called a "base" rate, but the multiple benchmarks for the old loans will continue.

Even "fixed" rate loans are no longer fixed — most banks will only offer fixed rate loans where they can reset the rate every few years, which is as good as floating rate loans with a staggered reset cycle. Recently banks offered "teaser-rate" loans — a lower rate for a few years before going back to a floating rate system; if the current sequence of interest rate increases continues, the "resets" will be to a point that will increase EMI payments substantially — for instance, a 3% increase in rates when reset (from 8 to 12%) will result in a 23% increase in EMI.

And then there are pre-closure charges, between 2% and 3%, ostensibly to prevent customers from going to another bank — but banks will charge some part of it even if you change from fixed to floating with them. Finally, you need to take on life insurance in case you die before you repay — that adds an extra annual cost.

These "innovations" have just made products more complicated. The banks' nickel-and-dime customers — a fee here, a charge there, an unmentioned cost somewhere else. In the process of offering something for everyone, they've muddied the waters for everyone — and the lack of knowledge is harnessed by bankers and intermediaries to mis-sell. Flexibility is, to the uninformed, a curse.

(Read the Entire Article: Innovations and Curses)

Comments deeply appreciated.

Btw, the Yahoo Columns have been reorganized but some links are orphaned. I’ll be fixing that soon, or posting the entire article on this site.

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