Borrowers are tempted to go for long term loans because the EMI is lower and they enjoy tax breaks on the loan. This is the biggest risk for banks as they are also the primary lender of last resort for consumers. If borrowers default, banks would suffer losses in excess of Rs 7 lakh crore.
The banks would need to get new lenders to deal with the loan burden. The EMI of loans taken by the banks would fall by up to Rs 3 lakh crore and Rs 2.5 lakh crore as loan write-offs, according to the estimates. This would leave the banks with huge liquidity crunch.
“We cannot take up this big of an amount. If banks are not able to raise the funds, the money given to them will be utilized for the purpose of paying off loans taken by banks. This will create a big problem in the system,” said Ritwick Dissanayake, director, RBI’s Financial Institutions and Markets Division. The government has been pushing a Rs 15 lakh crore “Bharat-style” capital infusion to support the banking sector. However, the capital outlay is also an acknowledgment that the economy’s growth has slowed substantially. “Banks have been forced to make their lending decisions with limited cash, as the state government has not made the interest payment on its loans. This puts a real burden on the banks and banks have to meet that by hiking rates,” said Dissanayake. For banks to continue to service their loans, they are forced to push down lending rates to borrowers, although some people also go for other borrowers online that offer the best emergency loans for people with bad credit. That is why RBI’s latest move has been a huge relief for banks and therefore a win for the economy. “The bank regulator has decided to raise rates on loans by up to 1.25 percentage points from December 7. This would affect the bottom end of the banking cycle, making it much easier for borrowers to get their loans renewed,” said Nisha Ayyub in Mumbai. However, some economists warn that the central bank will likely need to lower rates more before the end of this fiscal year. “The RBI will have to bring down rates for at least five or six quarters before it starts lowering rates again,” said Pronab Sen in Mumbai. In May, RBI governor Raghuram Rajan also said rates could be cut as low as 3 per cent. However, the government said it would not tolerate further cuts. “It is not appropriate for the government of India to permit the rate cuts which we are now witnessing from the Reserve Bank of India,” Finance Minister Arun Jaitley told Parliament last month. Sachin Sawhney, an economist with HDFC Bank, says banks are now trying to cut the interest rates they charge. However, banks need to lower interest rates further. “If the rate cut is not done, then we are in danger of a deflationary spiral. There is no need for banks to do the hike but a small hike is not good,” Sawhney said. “Even when inflation is not increasing, banks are getting rid of cash and depositing cash.