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Should Banks scrap loan prepayment penalties?

Created by : Ekta Dutta, Hedge Fund Analyst/Trader, ING Vysya Bank  | 09 24 2009 12:15:37 +0000
Industry : BankingFunctional Area : Business Policy(Strategy & Execution)
Keywords : banks banking rbi loans central bank commerical banks
Activity:  1326 views;  last activity : 03 24 2011 08:06:32 +0000

The RBI says it disapproves of loan prepayment penalties. It stated that it did not approve of such penalties and had advised banks to this effect, calling for self-regulation measures to put an end to such practices. Should banks scrap levying prepayment penalties. What's your take on this?

  
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Here I want to bring another point in to notice that the EMI's (equated monthly installments) are formed by such formula that early installments have most of the part as Interest only and only the small amount is deducted from the principle amont. Subsiquent EMI has reducing interest part and principle amount increasing.

So banks gets automatically the most of the interest in very early years of a personal loan, and then also they are charging a pre-payment panalty ? Its a shame.

 Certainly a Bank understand better use of money than any individual, so bank can easily deploy the pre-payment amount somewhere else and earn the remaining part of their interest.
By Abhishek Garg, Lead Engineer, Alstom  09 27 2009 11:53:53 +0000
 
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It is true that interest on loan repayments are an important part of bank's income.

But as RBI did not approve of such penalties and had advised banks to this effect, calling for self-regulation measures to put an end to such practices, i would like to tell what Abu Dhabi Commercial Bank is doing.

They have an attractive policy where if the loan is partially repaid or closed after five years then there is nil cost to the customer. In the first two years there is a nominal fee of two per cent. These two per cent charge applied if the prepayment was made with funds already in the customer’s account. ADCB charged one per cent of the total prepayment amount if the customer prepaid between two and five years of taking the loan. There was no penalty after five years if the borrower repaid the loan from his own funds in his account. ADCB, however, charged three per cent if the mortgage was taken over by another lender at any time during the loan tenor.

The Banks can initialise these kind of practice without giving full waiver on repayment charges. Otherwise look at the global financial crisis for what can happen when banks aren’t conservative.
By Paresh Dhembare, Area Sales Manager, ICICI Bank Ltd  09 24 2009 16:24:17 +0000
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I Support
By Ashutosh , Team Leader -(Technical), XXXX  | 03 24 2011 08:06:31 +0000
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I fully agree with Abhishek, Chraging prepayment charges is not less than loot. Getting advance money can be utilised by banks to earn more money and it will be win win for both, Banks and customers
By Nagendra singh, manager, Deccan Cargo & Express Logistics Private Limited  | 02 14 2011 06:59:51 +0000
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I go with Mr. Abhishek
By Suryanarayan Murthy, Asst Vice President (Corporate Finance), A Hydro Power Project  | 02 14 2011 06:48:06 +0000
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Penalty is for those who do nto repay at all if the perosn has the modesty to pay the amount in full before his final due date then reward must be bestowed on that person and penalth must be removed
By Nikhil , Senior Manager, Insurance  | 04 03 2010 10:56:14 +0000
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Some banks are stil charging interest high post offering low interest loans. and thereis vast gap between plr and loan interest charged by them (12 to 14%!!!).

If loan panelty is not in existance, this malpractise by banks will stop due fear of losing loan accounts
By Bhupendra Shah, Consulting Financial Planner  | 10 07 2009 02:52:10 +0000
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Customer is the king !!! Hence, all banks should accept the fact that In globalised markets, customer have choices of other banks who can provide better service and satisfaction to customer. these hurdles should be removed for certain class of customers who have good repayment history and better relationship with banks
By ABHIJIT KULKARNI, Project Manager, BNP Paribas  | 10 01 2009 06:46:01 +0000
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I think the Banks should feel happy that the Customers are very loyal in refunding the amount borrowed and all Indians would not love to keep their debts for a long time.
By Kranthi Kiran, Managing Consultant - People Practices, Pro-Resource Consulting  | 09 30 2009 09:36:14 +0000
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two factors in any credit 1) willingness to pay 2) capable to pay .  banks should encourage the willingness of borrrowers to pay back. penalising someone who wants to prepay when he is capable , is immoral. 


By pnatarajan , Freelancer,  | 09 28 2009 02:53:28 +0000
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From customer's point of view, one should have full flexibility to schedule his loan repayment plan. Banks should only have a minimum regulation in this process, to safeguard that their loan processing cost is not more than interest income.
By Prakash Saitwal, Technical Support Manager, Aditya Birla Management Corporation P. Ltd.  | 09 25 2009 12:18:10 +0000
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I dont find any valid reason for charging Prepayment penalties by the Bank. There can be a fixed amount of prepayment penalty since , the interest income is not generated in the future. Presntly if you want to close the personal loan you have to pay a % of the outstanding loan amount and also fixed charges. 
By sowmya , Chartered Accountant/CPA, Viteos Capital Market Services  | 09 25 2009 00:44:04 +0000
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I agree with you Stephen. This charge has no logic and is in the nature of excessive milking of customers.
By Shirish Beke, CEO  | 09 24 2009 23:03:06 +0000
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Yes, they should. Even the RBI is against imposition of such penalties.


By Viktor Stephen, COO, I Entrepreneur  | 09 24 2009 12:33:54 +0000
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I agree with Kumar. The foremost priority for any business enterprise is to make money and it applies to bank as well. The probability if that the bank would have borrowed the money from other institution before lending it to consumers. Any prepayment will bring imbalance to the deposits/loans and ultimately affecting the balance sheet of the bank.

At the same time the banks also should come out with a formula wherein they charge at say 2 percent for the prepayment/foreclosure made in the first year of the loan and it should be reduced subsequently. Also, if the loan is takenover by another institution it should be charged at a flat 2 percent across the life of the loan.
By Ravi Chandra, Test Manager, Barclays Technology Centre India  | 09 26 2009 08:51:33 +0000
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Bank being a commercial enterprise targets profit. when it employs its system for loan, interest income for entire loan is sole motive. By prepayment loss suffered by bank is mitigated by charges levied, which are clearly justified. There should not be any question on scrapping it.
By yogesh ashok bokil, Credit/Control Manager, HDFC Bank  | 09 25 2009 14:16:13 +0000
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Making money from money  is the only business for all banks, giving loans to needy people is their upmost duty. If the loan repayment penalties (in case of flat rate of interest) is withdrawn banks will suffer crisis and fall in business, which happens to be any organization's one and only one objective.
By KUMAR SAURABH JHA, Manager-HR & Admin  | 09 25 2009 10:36:44 +0000
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I agree with paresh and I think Indian bank should also come up with these kind of innovative solution.  

Pares I could not understand one thing, if payment is made after 5 year from own fund account then there is no prepayment charges however if mortgage takes over by another bank then 3% charges apply. What difference it makes to the foreclosing bank if loan is paid by the borrower or taken over by other bank. If bank has to incur some administrative expenditure then they can charge some fixed amount from the borrower.

 
By Deepak Agrawal, Consultant, Independent Consultant  | 09 25 2009 04:35:54 +0000
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I believe that banks should not consider scrapping of loan prepayment penalties. Interest on loan repayments are an important part of bank's income. If the customer doesn’t keep up his part of the contract, banks are entitled to charge loan foreclosure penalty.
By Ekta Dutta, Hedge Fund Analyst/Trader, ING Vysya Bank  | 09 24 2009 12:17:02 +0000
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