Malpractices in Indian Bank Loans

Of late, owing to its resolve to increase the level of transparency in banking, credit card, housing loans etc., RBI has issued various notices to all commercial banks from time to time directing their attention towards this area. A case in point is provided by the RBIs Circular Guidelines on the Base Rate, ref: RBI/2009-10/MPD.BC/10.14.01/2009-10 dated February, 2010. It lays down several guidelines of the ilk Since transparency in the pricing of lending products has been a key objective, banks are required to exhibit the information on their Base Rate at all branches and also on their websites. Banks were then directed to announce their base rates based on the mentioned guidelines. Similarly, The Reserve Bank of India said on October 9th, 2013 that it did not have any problem with banks offering loans to credit cardholders while purchasing goods or services but there needs to be transparency with the process. "There is no ban on giving loans on credit cards. Don't charge 12% actually and claim that I am charging only zero per cent interest," RBI Deputy Governor KC Chakrabarty declared. Another notice issued by the RBI titled Pernicious practices of select banks deterring customer protection and accounting integrity, ref: RBI/2013-14/292 DBS.CO.PPD No. 3578 /11.01.005/2013-14 dated September 17th, 2013 criticizes the banks practices like befooling the customers through zero percent EMI schemes offered on credit card outstanding, where the interest element is often camouflaged and passed on to customer in the form of processing fee. Many such other practices were illustrated in the notice and the defaulters were advised to strictly desist from such practices. However, banks continue to follow less transparent practice with other products and most important among them is the interest paid on fixed deposits (FDs). For example, the FD pamphlets from most banks usually carry two columns - one for the interest rate and other for the "annualized yield". The explanation to the annualized yield column will also state that the "annualized yield is calculated on the basis of quarterly compounding for the entire tenure". The problem is not in giving the annualized yield, but in giving the wrong yield (i.e, much higher figures) to grab the attention of FD investors. For example, a bank offering an interest of 8.75% per annum for its 10-year deposits usually projects that the annualized yield for the same is as 13.76%. Though the actual yield will be slightly higher due to quarterly compounding, the compound annual growth rate (CAGR) for a 10-year FD will only be 9.04% and not 13.76% as projected by the bank. Understanding the calculations:- For the sake of ease, let us assume that the amount invested in the 10-year FD is Rs.1 lakh. Since the FD is compounded quarterly, 2.19% (i.e, 1/4 of 8.75%) of Rs.1 lakh is added at the end of first quarter. So the value at the end of first quarter goes up to 1,02,190. Similarly, 2.19% of 1,02,190 is added at the

end of second quarter and this process is continued till the end of 10 years. So the initial investment value of Rs.1 lakh grows to Rs.2,37,635 at the end of 10 years. Since this is an absolute return of 137.64%, banks divide this value by 10 years to arrive at the 13.76% yield. Although the above mentioned computation is correct, the fact that what they are projecting is the simple interest and not the compound annual growth rate. CAGR is the best way to compare return rates between two financial products and that explains why SEBI has made it mandatory for mutual funds to use CAGR while giving their historical returns. So in my view, these malpractices should be stopped because they are wrong both in word and action and are directly in contrast to repeated RBI guidelines which is trying to abolish them.

References:
www.rbi.org.in

http://articles.economictimes.indiatimes.com/2013-10-10/news/42903175_1_credit-offtake-creditcard-loans