Public sector banks, in a frenzy to cash in on the retail credit boom during the three years beginning 2003-04, had failed to price interest rate risks on fixed rate loans properly. In the process, these banks are now taking a hit on their margins.

Even though the cost of deposits has increased by almost 200 basis points in the last one year, public sector banks are stuck with fixed rate home loans given at 8-8.5 per cent, just 50 basis points more than floating rate loans at 7.5-8.0 per cent.

The pricing flexibility in floating rate home loans saw banks raising interest rates on these loans by 200-400 basis points during the period.

The banks had failed to anticipate the sharp unexpected rise in interest rates. In contrast, private sector banks have always been maintaining up to 2-2.25 per cent differential between the fixed rate and floating rate home loans.

About 10-15 per cent of home loans portfolios of large banks like State Bank of India [Get Quote] and Punjab National Bank [Get Quote] are given at fixed rates.

After having learnt the hard way, most public sector banks now price their fixed rate home loans at 125-300 basis points over their respective floating rates.

Most public sector banks have stopped giving fixed rate home loans. Canara Bank [Get Quote] last month decided to stop giving fixed rate loans. But some banks haven't still corrected the past pricing mistakes. Uco Bank [Get Quote], for example, still maintains only 50 basis points difference between floating and fixed rate home loans.

"We are discouraging fixed rate home loans. We are raising 3-5 year money at 10.5-11 per cent, so we have to lend at 13.5-14 per cent to recover costs,' said the chief financial officer of a public sector bank.

"Public sector banks did not charge a risk premium (on fixed rate loans), as the case should be, owing to factors like peer pressure and too much liquidity," said the executive director of a Mumbai-based public sector bank, who also did not want to be quoted.

IDBI is charging a fixed rate of 14.25 per cent on a home loan of 5 years, the maximum tenure for which it gives fixed rate loans. Bank of India has reacted by reducing the period for resetting interest rate on fixed rate home loans from 10 years to 5 years.

ICICI Bank [Get Quote], on the other hand, has removed the interest rate reset clause in its fixed rate product.

The 200 basis points premium charged by the bank, allows it to offer a pure fixed rate home loan as it hedges interest rate risks for a few years.