In major relief for home loan borrowers, the government has suggested that the public sector banks (PSBs) stop levying pre-payment penalty or foreclosure charges on home loans.
Banks impose penalty of over 2 per cent of outstanding principal on borrowers who repay in totality or a portion of their home loan ahead of tenure.

In a recent communique to public sector banks and the Indian Banking Association (IBA), the finance ministry advised lending institutions that there should not be any penalty in case a borrower pre-pays home loans from his/her own funds.

Public sector banks have already implemented the government's advice, said bankers and government officials. State Bank of India, for example, does not levy any pre-payment penalty on borrowers repaying loans from their own funds.

Other PSBs too have followed suit. However, private sector banks continue to levy hefty prepayment charges, which can go up to as much as 4 per cent of the outstanding loan amount of a borrower.

The department of financial services has issued the advisory, even as the Competition Commission of India (CCI) recently ruled that levy of pre-payment penalty on home loans is not anti competitive. (The Commission's investigative wing later took the opposite view, which favoured scrapping foreclosure charges on housing loans.) "No pre-payment charges may be levied by the lending institutions when the loan amount is paid by the borrowers out of their own funds," according to a finance ministry communique issued to the public sector banks as well as Indian Banking Association.

The ministry issued this advisory after discussing the matter with the Reserve Bank of India and Indian Banking Association, official sources said.
Retail loan portfolio of scheduled commercial banks grew 20 per cent year-on-year to Rs 3,15,862 crore in March 2010, as per RBI data.

Even though public sector banks have implemented the government's suggestion, Indian Banking Association, the lobby group of leading private and public sector banks, pointed out to the government that banks would raise interest rates if they are not allowed to levy pre-payment penalty.

The Reserve Bank of India, meanwhile, is also in favour of private sector banks pruning these charges, and keeping them in line with the average cost of funds. Banks enjoy operational autonomy and pricing freedom with regard to banking transactions including loans.

Bankers argue that pre-payment penalty or foreclosure charges are imposed keeping in mind the cost of funds and the issue of asset-liability mismatch.

Banks' term deposits are typically of 1-5 years duration, whereas maturity of the loans is usually 15 years plus, which results in asset-liability mismatch.

Source: The Indian Express
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