When banks face mounting non performing assets and struggle to recover money from top notch defaulters who flee the country, shouldn't they welcome repayment of loans ahead of time? That's the legitimate question on the minds of ordinary borrowers when they are slapped with prepayment or foreclosure penalties by banks. Whether the repayment is made with the borrowers own funds or through a 'take over' loan from another bank, should be extraneous.
Banks, however, have a different view. Prepayment directly affects their asset liability management. They may lose interest that could have been collected, had the customer not prepaid the loan. The unexpected inflow of funds takes times for its utilisation. This would be a loss of interest on such surplus funds as well. In order to offset this 'loss', banks levy prepayment charges from their customers in the event of foreclosure of loans. In many cases, the loan sanction letters are silent on pre-closure charges. And the loan agreements, which are always standard form contracts thrust on customers, invariably have a clause that 'in case of inconsistency between the agreement and the sanction letter, this agreement shall prevail.' This plugs any leeway for a different interpretation, making the agreement the final word.
Aside of what the respective parties feel, what does the Reserve Bank of India (RBI) which regulates banks have to say? In its Guidelines on Fair Practices Code for Lenders in 2008, the RBI mandated that loan application forms for all categories should have information about fees, charges, including pre- payment options to enable a meaningful comparison with the terms and conditions offered by other banks. In 2010, it warned banks that levying charges sans prior disclosure is an unfair practice. In 2012, RBI felt that “the removal of foreclosure charges/prepayment penalty on home loans will lead to reduction in the discrimination between existing and new borrowers and competition among banks will result in finer pricing of the floating rate home loans. In its circular May 7, 2014, RBI made it clear that “banks will not be permitted to charge foreclosure charges/prepayment penalties on all floating rate term loans.” However, this was only for “individual borrowers”. Then came a sort of fox trot by RBI throug
h a draft circular dated June11 , 2018, which sought to impose a withdrawal commitment of sanctioned funds. This effectively tightens the banks' grip on borrowers of working capital that will hit entrepreneurs.
The National Consumer Disputes Redressal Commission and the Supreme Court in State Bank of India Vs Dr Usha Vaid, had upheld the Delhi State Commission's finding that “no bank or for that purpose finance companies can be allowed to indulge in restrictive trade practices by binding the consumer to go on availing loans even if the rate of interest is much higher than the other banks and any such clause which operates adversely to the consumer has to be held as void and therefore not enforceable.”
Nationalised banks are amenable to writ jurisdiction as an instrumentality of the 'state' and covered by Article 12 of the Constitution. The Delhi high court in DLF Limited Vs Punjab National Bank had observed that “the banking activity in the country was nationalised to curb such malpractices and the nationalised banks cannot be permitted to continue behaving as loan sharks.” The Punjab & Haryana high court in Seema Tulisan Vs India Housing Finance Ltd. Referred to a 2011 circular issued by the National Housing Bank, that banks have been directed not to charge pre-payment levy or penalty on pre-closure of housing loans in two situations - where the housing loan is on a a floating interest rate basis and pre- closed through any source and where the housing loan is on a fixed interest rate basis and the loan is pre-closed by the borrowers out of their own funds. Take-over loans on fixed rates of interest are thus penalised.
Pre-closure clauses smack of a 'clog on redemption' and have a distinct anti-competitive ring. If another bank offers a better deal to customers, why should they be ring-fenced by their existing lender? Wouldn't it cause “an appreciable adverse effect on competition”? Portability is the new mantra in the marketplace. As banks are service providers, wouldn't pre-closure penalties attract Section 3(3) (b) of the Competition Act, as a limit or control on the provision of services? Two dissenting members of the Competition Commission in Neeraj Malhotra Vs Deutche Post Home Bank Finance opined that “there is no doubt that there is a contravention of Section 3(3)(b) of the Competition Act, 2002 as these banks have adopted a practice of imposing pre-payment penalty by way of a concerted action which in effect limits or controls provision of services which resulted into foreclosing of customers mobility and by hindering entry into the market and thereby no benefit is being accrued to the consumers.”
Semantics are also at play. The Chandigarh State Consumer Disputes Redressal Commission in ICICI Bank Vs Prem Kumar Verma observed that the terms 'prepayment' and 'foreclosure' are not the same. “These denote two different situations and are not interchangeable.” The commission relied on Mitras Legal & Commercial Dictionary for a definition of 'foreclosure'.
“The effect of foreclosure is that the conditional conveyance in a mortgage becomes absolute and the property mortgaged vests absolutely in the mortgagee.” Foreclosure charges “relate to the mortgage of immoveable property and is not synonymous for prepayment charges.”
For banks, prepayment is not necessarily better than default. The practice is to milk the honest suckers!
(The writer is an advocate at the Madras high court, columnist & author)
