Penalties for pre-paying loans might be banned if banks found guilty

According to report of the acting Director General of the Competition Commission of India, the competition watchdog in India banks – both public and private sectors are working as “cartel” by charging penalty from the customers for pre-paying loans.

In view of this, Commission has issued notices to around 20 banks including big players such as the State Bank of India, Punjab National Bank, ICICI Bank and HDFC among others. The final decision will be taken by the regulator after it receives replies from the banks. On the other hand banks are consulting law firms to get legal view on the issue.

According to the sources closely related to the investigation, banks are charging prepayment penalties to “limit competition or not to have extensive competition and also to discipline customers so that they don’t switch banks at a slight drop in interest rate”. On the other hand banks say pre-payment leads to asset-liability mismatches having a cost attached to it.

The sources added, “The banks have been acting in collusion and charging customers for pre-payment of loan. They decided to charge the interest after a meeting of the Indian Bank Association (IBA) in 2003 where it was decided that all banks would enhance fee-based income and charge customers for paying the loan earlier than the due date. They decided to charge the customers uniformly so that they don’t switch loyalties when interest rates drop”.

However banks charge interest on pre-payment of loan even before the IBA meeting, after meeting the system was formalized and became more organized. The sources said, “This is an anti-competitive behavior and in violation of Section 3 of the Competition Act, which deals with anti-competitive agreements.”

But after the IBA meeting the decision was circulated internally, which is also in violation of the Reserve Bank of India’s guideline.

The sources pointed out that RBI does not support such practices and it has given clear instructions that banks should not levy “usurious charges” and should not have “income without earning”. The RBI has clearly stated that banks must maintain transparency in case of charges and should not charge fee-based income, the source said. Buts the banks are not following guideline of both the RBI and the Competition Act.

Last year the Competition Commission of India (CCI) had received a complaint from the customers regarding the penalty charges imposed by the banks on pre-payment of loans. However the pre-payment penalties are being charged by the banks in order to discourage customers from retiring debt before the scheduled date and also to stop them from switching banks to take advantage of more competitive rates offered by rivals.

In case the Commission finds the banks guilty, the penalty on pre-payment of loans might be banned across the industry, the sources informed. This move of Commission will bring relief to many home loan borrowers who have little choice but to pay pre-payment penalty or stay on with their existing banks even though they have to pay a higher interest rate on their loans.