LoanRaja Blog- Personal Finance Guide

Last week, the Government said that liquidity crunch was the biggest problem facing the country today. The RBI also acknowledged that the global crisis is hitting India far deeper than was expected. Little wonder then that a flurry of announcements have been made, all aimed at easing the liquidity crunch and increasing credit flow.

The current credit crisis itself happened because lending rules became tighter and interest rates were hiked as Government attempted to stem inflation (caused largely by the increase in the global price of crude). Credit is the backbone on which trade functions and the lack of credit (coupled with the decrease in demand) has led to the drop in industrial production.

Now that crude prices have fallen and inflation is down to 8.98 percent, the RBI has seriously turned to the issue of increasing credit flow and reviving the economy. The RBI announced CRR cuts twice this month; cut repo rates by 2 percentage points and in its latest set of announcements it has increased the ceiling on NRE (Non resident expatriable) deposits in a bid to attract funds from abroad.

Targeting revival of the real estate sector, NBFCs and capital markets specifically, it has tried to increase the flow of credit to these areas. The risk weightage attached to the real estate sector has been brought down and provisioning requirements on residential housing loans, commercial real estate and loans and advances qualifying as capital market exposures have been reduced.

Liquidity measures in place; now it is turn of credit flow

The real estate sector and the SSI sector are particular concerns for the government, as they are both highly labour dependent and any slowdown in these two areas will be followed by large scale unemployment. To infuse funds into these areas, the RBI has come out with a Rs 2000 crore package to finance SSIs through SIDBI, and a Rs 1000 crore package to NHB. Housing finance companies registered with NHB have been allowed to raise short term foreign currency.

NBFCs and mutual funds can now avail of a special repo rate up to March 2009.
The RBI has also announced a longer period of concessional pre-shipment credit for exporters of 270 days, compared to the earlier 180 days. But it is debatable how far this will help because the real problem for exporters has been the drop in demand.

Going by initial indications, these announcements will take time to translate into anything tangible for the common man. The markets, for one, have not reacted with much enthusiasm to any of these measures. Banks too are not expected to jump at the prospect of lending to the real estate sector as the cost of finance has gone up in the last one year.

Last year’s inflation control measures and attempt to bring down exposure to the real estate sector backfired. Rather than decrease exposure, banks simply raised the interest on deposits and continued to lend at higher rates. To bring down lending rates right now is not a very attractive proposition.

Banks did not react to the earlier set of measures to infuse liquidity in October by increasing lending; they bought government securities instead. So credit flow to the sector will happen only when the banks get over their reluctance to lend to housing sector once again.

In the longer term, banks will have to come back to the customers, interest rates will stabilize and people will begin to buy houses again. Even now, home loan companies assert that loan off-take among the middle and lower classes (who want to have a house to live in, opposed to buying a house as in investment) has not really come down.

The drop in inflation and the cut in crude oil prices have also not brought immediate cheer to the common man. The Consumer Price Index is not expected to drop any time soon. The crude oil price cut is expected to be passed on to the consumer only after oil companies have made good their losses.

We will have to wait for the banks to get over their concerns to begin lending and improve industrial confidence to finally see the effect of the measures.

Competition in the high-yield personal loans market has increased with the entry of multinationals, private banks and Non-Banking Financial Companies (NBFCs). While banks have the advantage of low cost of capital NBFCs are free from many capital related requirements. They compete with banks in easy and fast appraisal and disbursements of loans. A present day borrower looks for more convenience, quick appraisal and decision-making, higher amount of loan and longer tenure. Banks may not offer the flexibility that a personal loan seeker expects.

This is where NBFCs are at an advantage. While they can’t compete with banks on lower interest rates NBFCs are competing very clearly on the service aspects by coming out with new products which offer larger flexibility to the client. Through innovative ways they are penetrating semi-urban and rural centres with limited reach of banks. In urban areas, NBFCs focus on segments usually neglected by banks like non-salaried individuals, traders, transporters, stock brokers, etc. But they have a higher rate of sticky loans.

Rising credit demand

India has a huge market for unsecured credit. Banks alone won’t be in a position to meet the growing demand. Although NBFCs are no replacement for banks they are snatching business from banks in personal loans, mortgage, insurance, car loans, AMC, MF distribution, insurance advisory etc. NBFCs are present where the risk is higher and chances of returns are higher. After facing stiff competition from banks in their traditional business of retail financing they have diversified to tap the opportunities thrown up by a fast growing economy. NBFCs know that the younger generation dreams big and is not averse to borrowing for an improved lifestyle.

Nationalized banks, private sector banks and multinational banks all offer personal loans. It meets a customer’s urgent need for cash and the lender is not bothered about the purpose of the loan. Eligibility norms, documentation and income criteria vary from bank to bank. So are the interest rates and other charges. Interest rate ranges from 12 to 30 per cent with a maximum tenure of 60 months. Customer’s advantage in taking a personal loan from a bank is that it will have well-established procedures and clear-cut norms on eligibility, income calculation and repayment. The cheapest personal loan is available at nationalized banks. The flip side is that processing may take more time than you have bargained for.

NBFCs’ strength

The core strengths of NBFCs lie in their strong customer relationships, good understanding of regional dynamics, service orientation, and ability to reach out to customers who would otherwise have been ignored by banks. Some of the leading NBFC players in the personal loan segment are CitiFinancial Consumer Finance India Ltd.,GE Money, Countrywide Finance and Cholamandalam DBS. Different NBFCs have different rates of interests and other charges. At the time of writing Countrywide Finance offers personal loans at 27 percent interest and 2 pc processing fee with 2 pc prepayment charge. CitiFinancial charges 22 per cent interest and 2 per cent processing fee with 4 percent prepayment charge. Though some players like Citi Financial and Fullerton go through a personal screening of customers, not everyone follows this practice.

In their bid to make a fast buck, NBFCs often hawk expensive loans to low-income groups, without seeking adequate income proof. Two successive defaults would bring the ‘unfriendly’ recovery agent to a customer’s doorstep. NBFCs are not as transparent as nationalized banks on the actual cost of personal loan. Borrowers at the time of sanction of loans may not be fully aware of the terms and conditions of the loans including rate of interest either because the NBFC does not provide details of the same or the borrower has no time look into detailed agreement. RBI directive last year to give a copy of the loan agreement to the borrower listing all the charges may improve the situation.

Comparative rates

Following is an example of how a public sector bank and an NBFC treat the same amount of personal loan with the same tenure. The amount of personal loan is Rs.25,000 with a two-year tenure:

Note: These rates may have changed, please check current rates at the time of applying

SBI Saral Personal Loan:
Interest rate : 14.5%
EMI : Rs.1,206
Processing fee : 1-2%
Prepayment fee : Nil after 6 months
Total interest : Rs.3,950.

Citi Financials Personal Loan::
Interest rate : 22 %
EMI : Rs.1,297
Processing fee : 2%
Prepayment fee : 4%
Total interest : Rs.6,127.

A personal loan is the most popular form of an unsecured loan available to consumers. Although we often see advertising from banks and finance companies making it appear very simple to get such a loan, its rarely as simple as that. Since the loan is unsecured banks go to great lengths to determine that your creditworthiness and repayment capacity is verified and secure.

Eligibility norms and requirements may differ slightly depending on the bank, but broadly fall in the two categories:

• Salaried persons between the ages of 21 and 60
• Self-employed individuals between 25 and 65

Lenders also have different policies for the minimum income requirement and maximum loan amount offered. For example, ICICI Bank would require a net monthly salary income of Rs 8,000 whereas HDFC Bank may accept Rs 7,000 and Citibank insists on a minimum of Rs 8,500. Public sector banks such as SBI and other nationalised banks have different eligibility levels for customers in metros, urban and non-urban centres. Some banks consider gross salary for income calculation. The loan amount also differs from bank to bank. The personal loan limit depends on the borrower’s profile, income, repayment capacity and credit rating.

For government owned banks minimum loan amount offered is usually around Rs.24,000 in metro and urban centres and Rs.10,000- in rural/semi-urban centres. The maximum loan amount can go upto 12 times net monthly income for salaried persons subject to a ceiling of Rs.10 lakh. But some foreign banks like Standard Chartered and Citibank have higher limits. Most banks have lists of approved companies whose employees will find it easier to get a personal loan.

Some banks also verify your application against a negative lists of professions. Banks will usually prefer to offer loans to employees or owners of reputed companies which lend a certain amount of lending credibility to their employees. You also have to reside within the prescribed city limits of the bank. Most public sector banks insist on a guarantor for personal loan even for existing account holders although some banks may offer better rates and discounts on other charges. You can increase your eligibility by clubbing the spouse’s income and taking a joint loan.

Banks and other lenders use direct sales agents normally to run a background check on the loan applicant to crosscheck the information provided at the time of application such as details on employment, salary and the place of residence. The bank wants to be convinced of your income and surplus available to service the personal loan. This is done to ensure that you are capable of making regular payments on your personal loan and repaying it on time.

Be honest in your income disclosures and keep your credit rating high. This increases chances that your loan will be approved quickly, but if you have defaulted on any loans it may go against you at the time of verification and in case you have ever declared bankruptcy it will be very hard for you to get a personal loan