If you are in the market for a home loan, you have the option of either going to a bank or non-banking financial companies (NBFCs), including housing finance companies (HFCs). Recently, the Reserve Bank of India (RBI) mandated that banks link their lending rates for floating rate loans to an external benchmark such as the repo rate, effective from 1 October 2019. This would ensure faster transmission of policy rate cuts to borrowers, effectively giving them lower interest rates if there are significant cuts in the benchmark, as has been the case with the repo rate in the recent past. However, this may not apply to NBFCs and HFCs. “Almost 40% of the home loan market is with NBFCs and HFCs, but there is no clarity on whether this regulation would extend to them,” said Gaurav Gupta, CEO, MyLoanCare, an online lending platform.
As the situation unfolds, we tell you the difference between banks and non-bank lenders when it comes to loan rates and other features, to help you choose what works for you.
No level-playing field
RBI’s mandate was passed in an effort to ensure faster transmission of policy rate cuts to borrowers. “The reason for RBI asking banks to change from marginal cost of lending rate) MCLR method to benchmark-linked rate is that the benefits of repo rate reduction are not being passed by banks to customers on a timely basis,” said Saurav Goyal, head of finance, Money View, a digital lending platform.
While banks are governed by RBI, NBFCs are governed by the Companies Act. Loans from NBFCs and HFCs are linked to the prime lending rate (PLR), an internal benchmark rate used for setting up the interest rate on floating loans. PLR rate is calculated based on the average cost of funds. NBFCs are free to set the PLR according to their business requirements.
However, according to Goyal, banks switching to benchmark-linked lending rates will have a trickle-down effect for NBFC borrowers. “NBFC borrowing is dependent upon banks and, hence, reduction in bank rate would mean NBFCs will also borrow at a lower rate and the benefit of the same will be passed on to customers,” he said.
Some experts argue that NBFCs and HFCs operate in a different space altogether. “A lot of NBFCs and HFCs came into being because they serve a niche that banks were not interested in because the niche was too small or the cost of credit delivery of banks would not be appropriate to service them,” said Sanjay Chaturvedi, chief executive officer, Shubham Housing Finance.
He added that since the repo window is not open to NBFCs and HFCs, the question of them linking rates to repo does not arise.
Banks vs NBFCs
Interest rates aside, given a choice, most borrowers in India would make a beeline for a well-known bank, since their loan disbursal mechanism has proven to be effective over time. Raj Khosla, founder and managing director, MyMoneyMantra, a financial services firm, said, “Any borrower would be best advised to first see if their needs are catered to by a bank. Banks have lower cost of lending, and more mature programmes and facilities, so the bandwidth of a bank to administer rate changes effectively will always be higher than that of an HFC,” he said.
However, there is a catch. “If the benchmark were to decline, there would be significant pressure on loan spreads as liabilities are at fixed rate. Beyond a point, banks would be unable to reduce liability rates due to competition from other products like mutual funds and government small savings schemes. Thus, if interest rates or the external benchmark were to decline, there wouldn’t necessarily be a market share shift from NBFCs to banks due to the inability of banks to reduce rates beyond a point on liabilities,” said Alpesh Mehta, senior vice-president and deputy head of research, Motilal Oswal Institutional Equities, a financial services company.
“If a person is eligible for a loan from a PSB (public sector bank), it would be an obvious choice over a loan from an HFC. If all things are equal, the customer would obviously be inclined to choose the option that is priced lower,” said Chaturvedi. But even if a borrower gravitates towards bank loans for reasons of reliability as well as well as better interest rates, they might not always meet the eligibility criteria. This can happen for many reasons, including the borrower having a bad credit score or the property in question not being approved by the bank. NBFCs and HFCs, on the other hand, have more relaxed policies towards customers with low credit scores, though they offer loans with high interest rates. This automatically positions them well to service customers who can’t access bank loans.
When shopping, people like to get what they consider a “good deal”. The same applies when they apply for a loan. So, banks offering a better interest rate might encourage borrowers to choose them over HFCs and NBFCs. But according to Chaturvedi, a better lending rate is not the only condition for gaining customers. “Even earlier, the larger lenders, whether banks or HFCs, had lower interest rates. It is not as though all the business went to them. People are willing to pay a premium for differentiated services, money may be fungible but there is more to a home loan. For example, besides fee and interest, there is the question of speed, doorstep service, eligibility norms, quality of collateral, flexibility and risk appetite,” he said.
Goyal agrees that HFCs provide a differentiated loan product and can, therefore, service a separate market segment. “The difference between NBFC and HFCs and banks has always been the ability of the first two to reach and lend to individuals who have not been able to get a loan from a bank or want to avoid the tedious process of obtaining a bank loan,” he said.
“A small change in EMI might not make a difference. Speed and accessibility of processing is equally important. HFCs and NBFCs provide doorstep service, whereas public sector banks make you go through an arduous process to get a loan issued,” said Mukesh Jain, real estate and banking law expert, and founder, Mukesh Jain & Associates, a law firm.
What you should do
Before you choose between a bank and an NBFC, keep in mind that the issue of linking loans to benchmarks is an ongoing process. Even before RBI had made it mandatory, several banks, including State Bank of India, Bank of Baroda and Oriental Bank of Commerce had launched repo-linked lending rate products. SBI has since put out a statement on the social media stating that the repo rate-linked home loan product stands withdrawn.
There is also lack of clarity about some aspects of the new benchmark-linked rate system. “RBI should clarify that once a spread has been fixed over an external benchmark, it should not change for the longevity of the loan. The current wording is not very clear,” said Gupta. He added that there is also some ambiguity about what charges would be involved for existing borrowers who wanted to switch from MCLR to a benchmark-linked rate.
On the other hand, RBI has turned its attention to NBFC and HFC lending rates too. RBI wants greater transparency and order in the rate-setting process at NBFCs and HFCs, Mint reported. The matter came up at an internal RBI discussion on external benchmarks. Read more.
Given that there is still some lack of clarity and more developments are emerging, it might be a good idea to wait till things settle down.
Banks and HFCs operate in different, though overlapping, spaces and both have their pros and cons. Since home loans are the largest long-term borrowing that most people make, looking at the tenure and interest rate is critical. So understand what you are signing up for before taking one.