How our banks are cheating us of our savings

Banks are cheating customers with rates that are unfairly high, discriminatory, and opaque, denying legitimate savings to borrowers, while the RBI has been looking the other way, says Debashis Basu.

Illustration: Uttam Ghosh/Rediff.com

Consumer issues come last on regulators’ priority.

Even the celebrated public intellectual Raghuram Rajan made only passing references to consumer issues, if at all, in his speeches.

And so, it was startling to note that my rant over four columns that banks are cheating those taking floating rate loans found a loud echo in the Report of the Internal Study Group to Review the Working of the Marginal Cost of Funds Based Lending Rate (MCLR) System, headed by Janak Raj.

Incidentally, the report has been on the RBI website for over a week now, but the media has somehow ignored its importance.

My point was that when interest rates go up, banks are quick to pass on the hike; when rates go down banks find a way to keep most of the gains with themselves.

In the mild, semi-academic words of the Study Group, 'The transmission to lending rates was asymmetric over monetary policy cycles -- higher during the tightening phase and lower during the easing phase -- irrespective of the interest rate system.

'For instance, the pass-through to outstanding loans from the repo rate was around 60 per cent during the tightening phase (July 2010 to March 2012), while it was less than 40 per cent during the subsequent easing phase (April 2012 to June 2013).'

This means in the easing phase, customers were cheated of 60 per cent of the benefit. This will run into tens of thousands of crores.

Shockingly, the report goes on to say: 'In the case of private sector banks, it took almost six months for the transmission from the lower MCLR to actual lending rates…in the case of public sector banks, the transmission was not complete even after six months.'

One of my columns had argued that the floating rate calculation leaves scope for mischief. Here’s what the RBI report says about it: 'The banks deviated in an ad hoc manner from the specified methodologies for calculating the base rate and the MCLR to either inflate the base rate or prevent the base rate from falling in line with the cost of funds.

'These ad hoc adjustments included, inter alia:

'(i) inappropriate calculation of the funds;

'(ii) no change in the base rate even as the cost of deposits declined significantly;

'(iii) sharp increase in the return on net worth out of tune with past track record or future prospects to offset the impact of reduction in the cost of deposits on the lending rate; and

'(iv) inclusion of new components in the base rate formula to adjust the rate to a desired level.'

This simply means that rates were kept artificially high, denying legitimate savings to borrowers.

If these are the words of the RBI’s own study group, what is the RBI’s role here?

The RBI always takes a benign view of anti-consumer banking practices.

Indeed, since 1999, through a nicely couched term called “forbearance”, the RBI has progressively allowed Indian banks to have a free run on the customers’ wallets.

No wonder the Study Group found: 'Variations in the spreads across banks appear too large to be explained based on bank-level business strategy and borrower-level credit risk.

'In particular, spreads charged by some banks seem excessively and consistently large. The analysis suggests that the spreads were mostly arbitrarily changed by banks for similar quality borrowers.

'While the spread over the MCLR was expected to play only a small role in determining the lending rates by banks, it turned out to be the key element in deciding the overall lending rates.

'This has made the entire process of setting lending interest rates by banks opaque and impeded the monetary transmission.'

The report goes on to say: 'That many banks tended to charge the spreads over the MCLR arbitrarily is evident from a special study of select banks conducted by the Study Group.

'The key findings are:

'(i) large reduction in (the) MCLR was partly offset by some banks by a simultaneous increase in the spread in the form of business strategy premium ostensibly to reduce the pass-through to lending rates;

'(ii) there was no documentation of the rationale for fixing business strategy premium for various sectors;

'(iii) many banks did not have a board approved policy for working out the components of spread charged to a customer;

'(iv) some banks did not have any methodology for computing the spread, which was merely treated as a residual arrived at by deducting the MCLR from the actual prevailing lending rate; and

'(v) the credit risk element was not applied based on the credit rating of the borrower concerned, but on the historically observed probability of default (PD) and loss given default (LGD) of the credit portfolio/sector concerned.'

Lack of space prevents me from elaborating more on this explosive document, widely ignored by the media.

A plain reading of the report conclusively proves that banks are cheating customers with rates that are unfairly high, discriminatory, and opaque, while the RBI has been looking the other way.

Debashis Basu is the editor of www.moneylife.in.