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Monthly interest must not raise loan cost: RBI

The Reserve Bank of India today directed banks to ensure that the effective rate of interest does not go up when they switch over to the monthly rest system of charging interest to the borrowers.

This, in effect, means that banks will have to bring down the applicable interest rate to maintain the current yield on advances and avoid increasing the burden on the borrowers.

The central bank has given three options to banks to compound interest at monthly rest either from April 1, 2002 or July 1, 2002 or April 1, 2003.

At the time of changing over to monthly rests, banks may obtain consent letter or supplemental agreement from the borrowers for the purpose of documentation. If the banks do not pare the interest rate suitably, the cost of the borrowers will go up marginally when they shift to the monthly rest system.

For example, in the case of a bank charging a borrower an interest rate of 12 per cent at quarterly rests, the effective yield works out to 12.55 per cent. Should the bank charge the same borrower an interest rate of 12 per cent at monthly rests, the effective rate rises to 12.68 per cent.

The RBI has directed banks to adjust the 12 per cent interest rate charged to the borrower in such a manner that the effective interest rate does not exceed 12.55 per cent. Thus, in light of the example given, banks should charge interest at 11.88 per cent (and not 12 per cent).

If this is done, the effective rate, even after compounding at monthly rests will be 12.55 per cent.

The RBI stated in a circular to banks that the application of interest on monthly rest basis will be applicable to all running accounts - cash credit, overdraft and export packing credit accounts.

Interest at monthly rests shall be applied in case of all new and existing term loans and other loans of longer and fixed tenor. Here, banks will have to apply interest at monthly rests at the time of review of terms and conditions or renewal of such loan accounts or after obtaining consent from the borrower.

However, this will not be applicable to agricultural advances. The banks can continue to follow the existing practice of charging interest on agricultural advances linked to crop seasons.

Some of the bankers said it would be very difficult to charge interest rates on a monthly basis as the borrowers are not in a position to pay this.

"The financial system revolves round the quarterly rest basis and the company's cash flow is also in tune with this. They will not be able to pay interest monthly," said a bank chairman.

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