Banks not ready to withdraw prepayment penalty on foreclosure

The Competition Commission has sent notices to at least 15 banks, NBFCs and IBA seeking explanation on why they penalise borrowers who choose to foreclose loans

Indian banks have expressed concern over the intervention of the Competition Commission of India (CCI) on the home loan prepayment penalty issue as they fear that this would put pressure on their costs, increase risk and even lead to higher lending rates, reports PTI.

Last month, CCI, the apex body that operates to sustain and promote competition, sent notices to at least 15 banks, non-banking financial companies (NBFCs) and the Indian Banks’ Association (IBA) seeking explanation on why they penalise borrowers who choose to foreclose loans.

In the communication, CCI is understood to have observed that loan prepayment penalties will suppress the competition in the home loan market by limiting the chances of a borrower to switch their loan to another lender.

Banks which have been asked to explain this matter include State Bank of India (SBI), ICICI Bank Ltd, Axis Bank Ltd, Punjab National Bank (PNB), Canara Bank, Indian Overseas Bank (IOB), Indian Bank, Oriental Bank Of Commerce (OBC) and HDFC Bank Ltd, amongst others. Besides, home financiers like Housing Development Finance Corp Ltd (HDFC) and LIC Housing Finance Ltd were also served notices by CCI.

According to sources, many of these institutions have already replied to CCI, to make it clear that the removal of prepayment penalty will result in higher lending risk and may cause asset-liability mismatch in banks.

IBA, which is the industry lobby of Indian lenders, said banks would send their responses individually to CCI as early as this week.

“IBA’s view is that this (prepayment penalty) does not violate competition laws. Moreover, if CCI insists that banks should stop penalising foreclosures, banks will have to hike the lending rates by at least 0.25% to cover the risk,” a top IBA official told PTI.

IBA would respond to the CCI’s notice this week, the official said.

Presently, most banks charge prepayment penalty in the range of 1%-2% in the event of a customer opting to close the home loan prematurely. Banks do this with a view to cover the interest loss due to the foreclosure of the loan.

What irked CCI is the fact that some institutions are charging higher penalties as high as 3% to 4% to discourage customers from switching their loans to another bank or a financial institution, the official said.

SBI, which charges around 2% prepayment penalty for premature closures within three years of availing the loan, said the penalty is necessary in the system to avoid any asset-liability imbalances.

“Prepayment penalty is an accepted norm in all developed markets across the world. Banks give loans for a specified maturity and raise liabilities (deposits) to lend. During foreclosures, banks will have to take a hit in cost terms. This necessitates (the) prepayment penalty,” a top SBI official said.

Besides, the costs of all borrowers are likely to go up if banks stop penalising customers for loan foreclosures as banks will be forced to hike lending rates to cover the interest loss, the official added.