Banks are having the last laugh even as they reduce base rates, because they won’t lose money from customers who should, but won’t see a rate cut.  For some of the banks the rate that should “float” – that is, have borrowers pay less interest when the base rates fall – are not going to. For you as a home loan borrower, you should think twice before rejoicing that after SBI, even Axis Bank, ICICI Bank and HDFC Bank have cut base rates; the cut could probably not apply to you.

In particular, Home loans that you “thought” you got from HDFC Bank may not at all change rates. You see, you go to the bank, the banker sells you the loan, you sign the documents and give your money. But you don’t get a loan from HDFC Bank – you get a loan from it’s group company, the big daddy Non-Banking Finance Company called HDFC. This is a different company altogether, and as an NBFC does not even need to have a “base rate”.

HDFC is not the same as HDFC Bank

To understand this better, let’s change the name of HDFC (the non banking entity) to “XXXX”.

And here is the clincher. While your loan was given to you by XXXX, the HDFC bank – a completely different entity – will then purchase the loan from XXXX. So when you pay XXXX, it deducts a fee and pays HDFC Bank whatever you’ve paid it. Effectively your loan is owned by HDFC Bank and not XXXX, but you don’t know it.

And guess what, because XXXX is a different non-banking entity, it does not need to have a base rate, so effectively even if HDFC Bank reduces its rates, you don’t see it because your loan was originally from XXXX.

Don’t believe me? See this page called “Home Loans” on the HDFC Bank web site. This is the bank site, but it’s peddling loans from HDFC – the logo is different. 

What are you talking about?

RBI mandated base rates for banks. Because banks were using different rates for different people. They were saying look we have existing customers with 10% rates, let them be “benchmarked” to a rate called the “PLR” or a “Prime Lending Rate”. For new customers we will create a “PLR 2” which is also a benchmark rate but only applicable to new customers, so we can get new customers at 9%, but maintain that existing customers pay 10%.

RBI didn’t like this. If it cut rates, then the rate cut would only flow to new borrowers, while old ones are miffed. It then said that all banks need to have a single base rate below which they can’t lend and all “floating” loans should be linked only to this base rate.

Nearly all car loans, personal loans and credit card loans are fixed rate, so they would anyhow remain unaffected by a cut in the bank’s base rates. But housing loans (and many corporate loans) are linked to the base rate, for about six years now.

If the base rate of the bank changes, all loans linked to it change accordingly, and immediately. Till now this was fine because banks were only increasing rates. RBI enforced this rule for banks, but not for non-banking companies, who could have different PLRs etc. Why? Because they don’t get access to RBI funding (repo window) and have to borrow from the market, so they were given a little more freedom.

But RBI did say that if anyone wants to exit a home loan product even from an NBFC and shift to a bank, they should not be charged a pre-payment penalty – this was to improve transmission.

The Rate Cut Cycle Makes For A Strange Issue

As rates fall, you expect that rates go down when a bank cuts rates. But there’s something strange happening, with the likes of HDFC Bank.

HDFC Bank has home loans. But it doesn’t, for the most part, lend directly to its borrowers. 

When you go to an HDFC Bank branch, you can get a home loan. But that home loan comes from HDFC, an entity separate from HDFC Bank. HDFC is actually the home lending non-banking behemoth. HDFC Bank is only an agent that helps “originate” the loan, but HDFC actually lends the money. HDFC Bank gets “processing fees”.

Then, a funny thing happens. HDFC Bank decides it wants home loans too, but it doesn’t lend directly to the consumer. It goes to HDFC, and buys loans from it. It pays HDFC money to transfer the loan to its own books. Then when you pay HDFC the EMI, it takes the money and passes it through to HDFC Bank, and there could be a small fee it deducts.

What that means is: Your loan, which you got in an HDFC Bank branch, and now is owned by HDFC Bank, is actually governed by rates of a completely different issuer: the parent HDFC. In effect, when HDFC Bank cuts its rates, your rates are not cut, as the rate you get is linked to a loan by the parent HDFC, not by the bank.

Turns out other banks have warmed up to this and ICICI Bank too has gone down this way. Monika Halan tweets:

This is incredible, no?

NBFCs Might Cut Too…But Only for New Customers

You would think NBFCs would cut rates too, like banks are.

Correct. But NBFCs can have multiple “PLRs” and have a new benchmark only for new customers. Which means your loan could be linked to an “old” benchmark, while someone else who’s new gets a lower benchmark to deal with. 

What Can You Do?

If you own a loan whose rate isn’t changing (please call and ask), you have only one option: Transfer away your loan.

A new loan from a different bank will give you a lower rate, and no one can charge you a pre-payment or early exit penalty to do so. You can then avail of better rates.

And you can use even an allocation letter from another bank to force your lender to match the lower rates. Most NBFCs charge you money to change the rate, but if you threaten them with closing the loan and moving to a different provider, they will probably put their tail between their legs and remove all charges. Please note: get a confirmed letter from them about the ZERO charge before you do this. If they refuse to give you a letter, transfer your loan out. Do not trust a banker’s word, only the written form.

Is it time for the RBI to act?

Should the RBI make a base rate compulsory for NBFCs too? It should, in my opinion, but the typical NBFC complaint is – they don’t have access to the transmission windows that banks have. NBFCs can’t borrow from the Repo window, so they shouldn’t be regulated as much as banks are.

Which could be true, but it is also unfair if banks own home loans by this roundabout method of issuing them through a partner-group entity, and then buying back the loan, just to avoid the loans being actually floating rate. 

The banks’ defense will be that look, anyway a person can shift loans without a penalty. But it is a huge pain to shift a loan to another bank; and if the other bank also choose to issue loans through a (wink, nudge) group NBFC, then you hit this wall again. 

RBI should stop this regulatory arbitrage, and when banks buy loans from other FIs, either ensure it isn’t a loan from a related party, or demand that such loans can only be bought if they are linked to a single base rate that applies for all loans of the issuer. I.e. NBFCs can have different PLRs if they want, but if they do, they cannot sell their loans to banks. Only single base rate NBFCs will be allowed that liberty. 

What do you think? (Also, do tell me what part of this is wrong. )

Note: As of Sep 30, HDFC Bank had over 19,000 cr. of housing loans on its book, but it doesn’t sell home loans. We do know from their past annual report that they bought Rs. 5,500 cr. of loans from HDFC. This may not be much (it’s just short of 10% of their total retail loans) but it is big enough. 

Now, tell them about it: