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Are we mimicking sub-prime?

By BS Reporter in New Delhi
March 03, 2009 16:38 IST
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State Bank of India has offered home loans at a concessional rate of 8 per cent for a limited period. It has now extended that to other consumer loan categories, like automobiles.

Those taking the home loan will enjoy the low rate for a year, after which it will be reset, at a higher four-year fixed rate for loans below Rs 20 lakhs (Rs 2 million), and at the then floating rates for larger loans.

Everyone, including existing SBI customers, currently pays a rate of interest which is higher by 2 percentage points or more than the first year's rate. SBI contends that the savings in the first year itself will be substantial -- Rs 40,000 for a Rs 20 lakhs loan.

Still, the gambit has attracted criticism from private sector competitors. HDFC chairman Deepak Parekh has called the offer a gimmick which won't benefit the customer in the long run. It will also not enlarge the size of the total home finance cake but seek to wean away customers from other banks, he says.

It seems illogical to blame SBI for under-cutting rivals or not increasing the size of the housing pie.

If it makes housing cheaper, it is doing its bit, and it is entitled to undercut rivals. SBI, as a state-owned bank, seems to be using its comfortable liquidity position and low cost of funds to respond to the government signal to cut interest rates, without giving too much away.

Other banks and institutions can respond by also lowering their rates, but everyone may not be in a position to do so. ICICI Bank, for instance, has moved away from retail loans as a matter of policy, citing rising delinquency rates.

And the fact is that, in the current climate of uncertainty, many savers have moved their money from private banks to state-owned ones -- which now gives these dowdy dowager banks the advantage over younger, more sprightly rivals.

If SBI can be faulted, it is for mimicking US mortgage lenders in the sub-prime market.

They offered low interest rates in the initial period of a mortgage loan in order to bring in the customers, with the proviso that interest rates would rise during the tenure of the loan -- a point that many borrowers did not properly register.

The danger in following this practice is that it could lower the quality of assets, invite borrowers who may not be good credit risks, and thereby buy a future headache. SBI might argue that it is not relaxing its norms to attract loan customers, but a housing loan is a long-term engagement and short-term sweeteners encourage riskier borrowing behaviour.

It is worth bearing in mind that one reason why delinquency levels began to rise on housing loans was that many borrowers who had opted for floating rate loans at a time when rates were low, were caught off guard when interest rates went up in 2007 and 2008.

This risk still exists; those taking loans today at 8 per cent might find a couple of years down the road that interest rates have climbed as the economy picks up steam, and that the monthly loan repayment instalments have become a burden.

Admittedly, Indians borrowing for housing usually put in much more equity as down payment than was the case in the US sub-prime market, but SBI would be well advised to be careful before it goes further down the road of offering low entry-level rates.

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BS Reporter in New Delhi
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