Tuesday, February 10, 2015

Truth in lending: Regulatory Measures in India

[The following guest post is contributed by Neha Somani of Vinod Kothari Consultants Pvt. Ltd. The author can be contacted at nehasomani@vinodkothari.com]

Truth-in-lending laws, found in many countries world-over, ensure that lenders make a truthful disclosure of their rates of interest, and do not seek to attract borrowers with misleading rates of interest. Truthful disclosure of rates of interest is as important as fair disclosures made by a vendor selling goods. There was a time when there was no truth-in-lending in India at all. A lender could get away with disclosure of what was called "flat rate of interest", which was almost like half of the actual interest rates. Leading housing finance lenders would show what was called "annually declining rate of interest", which was also was deceptively lower than the actual interest rates.

The Truth in Lending Act (TILA) of 1968 is United States’ Federal law that requires lenders to provide standardized information so that borrowers can compare the loan terms and take their call accordingly. It has been implemented by Regulation Z (12 CFR Part 226). Regulation Z has been considered as one of the most complex and broad regulations in the consumer lending space. Compliance with this regulation has become increasingly more challenging over the last few years. Contrary to popular belief, the Truth in Lending Act does not regulate the charges that may be assessed against consumer credit.  Instead, it requires a standardized disclosure of the charges and costs that consumers can then compare with other creditors. It is intended to ensure that credit terms are disclosed in a meaningful way so that the consumers can compare credit terms more readily and knowledgeably. This is done to stabilize the economy and encourage competition amongst financial institutions by keeping their consumers informed about the terms and conditions of the credit for which they are applying. 

Before its enactment, consumers were faced with a bewildering array of credit terms and rates. It was difficult to compare loans because they were seldom presented in the same format. Now, all creditors must use the same credit terminology and expressions of rates. At the application stage, disclosure of terms and conditions allows the consumer to compare credit offers from different financial institutions. At the acceptance stage, full disclosure of terms and conditions allows him, to adequately predict how much the credit arrangement will cost him and whether it is an appropriate financial move.

Two of the most important terms regulated by this Act are finance charges and the annual percentage rate. Both of these terms may be difficult for a lay person to understand, may vary from lender to lender, and may greatly impact a consumer’s personal finances. The Act explains that the amounts of both the finance charges and the annual percentage rates need to be disclosed and may not vary significantly from the disclosed values. This is essential for the consumer’s understanding of the credit terms and ultimate repayment amount.

There are both civil and criminal penalties if the Act is violated. Creditors can be liable for violating the disclosure terms of the Act even if the consumer was not hurt by the violation unless the creditor fixes the error within 60 days of notification or proves that the error was made unintentionally. If a creditor does not comply with the requirements of the Act, the consumer can file a lawsuit within one year of the alleged violation. Willful violations of the Act could result in criminal charges being brought and sentences of fines and prison time being imposed.

RBI barred suppliers’ subvention financing 

The Reserve Bank of India (RBI), through its circular dated September 17, 2013, took the high moral ground in directing commercial banks to desist from certain “pernicious practices,” which, in its view, “deter consumer protection and accounting integrity.” At the core of its directives, was the fairly widespread practice of certain banks which offer retail loans at “zero per cent” interest to purchase high value consumer durables such as LCD TV sets, high-end refrigerators, and the like. Arguing that there is no such thing as an interest-free loan, the RBI laid down guidelines to make a large swathe of retail lending by banks more transparent. Subvention, as well as moratorium on payment, are fairly common practices to boost sales. There has been a disquieting tendency among banks of not giving their customers information on the full extent of such concessions. Even more unacceptable has been the practice of part-loading these to the interest rate charged to make the latter appear lower. Through this notification, banks were asked to pass on the benefits to their consumers “fully and indiscriminately”, without camouflaging them in the form of lower interest rates. Thus, a discount on the price would mean a lower quantum of loan. It also stated that repayment of the loan would commence only after the moratorium period.

Credit card issuing banks quite often promise an interest-free EMI loan if a particular card is used for a particular purpose- saying, booking of a travel. There are no free lunches in life; neither is there any interest free credit in the world of banking. Here, zero interest is a misnomer because the borrowers are charged a high processing fee.  It is just that the bankers are getting merchant commissions from the respective merchants offering the services - in this, the airline or the travel company, from which the interest is being made up. Canons of transparency require all such fees to be uniform across all products and segments. It was also stated that no fees would be charged on debit card transactions by merchants. Considering the overall scenario, consumer protection is far more vital than a short-term dip in sales of consumer durables, which will rebound over time anyway. By seeking to make expensive products affordable to even those who cannot really afford it, the “zero-interest” schemes, which were not really doing that, were ultimately drawing consumers into a debt-trap. Hence, this notification came into picture at an appropriate time.

Supplier subventions were a common phenomenon all over the world of asset-backed financing - manufacturers of automobiles, commercial vehicles, construction equipment, even IT sector - all actively try to promote the sales of their products through subventions. This notification put a curb on subvention-based financing in India.

Non-Banking Financial Companies - Micro Finance Institutions (NBFC-MFIs) are required to provide a copy to the borrower of a standard loan agreement form, alongwith the terms and conditions of the loan, which include the annualized interest rate and method of application. The borrowers must be provided a summary loan card, which shall include the following information:

- Effective rate of interest charged
- Terms and conditions of the loan
- Information that are sufficient for identification of borrowers
- Acknowledgements by the NBFC-MFIs, with regard to the repayments

Non-compliance with these directions would tantamount to imposition of the penal provisions under the Reserve Bank of India Act, 1934. The NBFC-MFIs and the banks that lend money to them, both have to play the monitoring role as well.

Steps taken by RBI to ensure transparency

The RBI through its Circular dated January 22, 2015, has instructed banks to adhere to the following instructions, which shall come into effect from April 1, 2015:

- Banks are required to disclose on their websites the range of interest rates of the loans contracted with the individual borrowers, in the previous quarter.

- The average interest rate of the abovementioned loans is also required to be displayed on the website.

- At the time of processing of loans, the entire fees and all related charges, including the processing fees should be disclosed to the borrowers, as well as displayed on the website of the banks.

- Banks should disclose the Annual Percentage Rate (APR), to show the total cost of credit on loans to individual borrowers.

- Banks are required to give an explicit and lucid statement/ fact sheet to all the individual borrowers, at each stage of loan processing and also when the terms and conditions of the loans undergo change.

Relevance of the concept of truth-in-lending

By having a uniform standard for presenting the terms of consumer credit, individuals have a much easier time of comparing and thus, choosing the best credit option.  Instead of information being shielded and hidden from the consumer, this gives power back to consumers as they need to make informed choices about credit. Before the concept of truth-in-lending came into picture, consumers were not able to compare the interest rates and loan costs, properly. Frauds and scams were therefore, rampant because the lenders used to take advantage of the fact that the consumers were not able to make comparison between the credit options. Hence, taking cue from the global scenario, India definitely needs stringent norms and laws with respect to truth-in-lending. The recent RBI notification covered here, is definitely a major step to imbibe transparency and authenticity in the transactions of banks with the individual borrowers.

- Neha Somani


Madhusudan Bose said...

Nicely written ... Good for layman readers like yours truly ... Thank you ...

vswami said...

The write-up by the learned lawer has brought to light certain worrisome aspects of the most concern to the borrowers from banks. The truth/transparency requirements and the attendant norms as laid down by the RBI, the semi-regulatory authority are accordingly confined to commercial lending; of course should equally hold good for other borrowings such as, home loans.
On the flip side, however, there is a similar , rather a greater stress, warranted , for obvious reasons, to be laid on disciplining the lending institutions in regard to the accounts/deposits holders whose monies are , in fact, employed for lending. This is a crucial area which has thus far remained to be investigated and remedial measures taken by the RBI, unwittingly or otherwise; so much so, the genuine grievances of sorts, of the accounts/deposits holders have been left unattended, causing immense hardship/hassle routinely faced by them, with no solution in sight thus far.
For a revealing frightful hint, attention may be invited to, among others, a recently published article in the website of ‘money- life’ on the topic, - Banks are ripping off Consumers in many ways. Will PM Modi & Arun Jaitley question them? . To view the comment click here. To be precise, refer the comment there under, in which, a real life instance of a leading bank,- may not be the only solitary instance, -and its ongoing practice, with no let-up, of unscrupulous charge by way of reckoning afresh, and reducing interest otherwise already accrued due, on withdrawals of own monies in deposit, if done before the stipulated period; and adding insult to the injury, further reduce additionally '1%' of the deposit, The most objectionable part of it is that it has been doing so, despite the actual fact no clear cut term / condition stipulated by bank or made known to the depositor at the time of placing the deposit.
As pinpointed therein, the view taken by the RBI Ombudsman himself , that too in a case of foreclosure of home loan, ref. – Bank pulled up for 'deficient documentation' | Business Line, needs to have been made a conscious note of by the RBI, but not known as done so far.