After tightening the criteria for extending top-up loans against movable assets in November 2023, the Reserve Bank of India may do likewise with other top-up loans given by commercial banks and non-banking financial companies (NBFCs).
The RBI, in its latest Report on Trend and Progress of Banking in India 2023-24, observed that it will assess the need, if any, for additional regulatory interventions to mitigate the identified risks in cases of “other top-up loans”.
Additional loan
A top-up loan is an additional loan a borrower takes on his/her existing home or personal loan even as he/she is in the midst of repaying it. This loan is usually given if the borrower has been repaying his/her loan on time. Other top-up loan can include an unsecured personal loan or a microfinance loan.
The central bank noted that while top-up loans provide additional credit facilities to customers on the strength of their existing collateral such as houses, automobiles or gold, many lenders may perceive such secured loans as having lower risk.
Hence, such additional facilities are often sanctioned with minimal processes and due diligence, with liberal underwriting standards and lax adherence to prudential guidelines on loan-to-value (LTV) ratios, risk weights, and without ensuring the end-use of funds.
“These practices could lead to build-up of risks, especially during times when collaterals for such loans become volatile or face cyclical downturns,” cautioned the central bank.
In view of these concerns, the RBI in November 2023 had instructed that all top-up loans extended by lenders against movable assets, which are inherently depreciating in nature, should be treated as unsecured loans for credit appraisal, prudential limits and exposure purposes.
Banking expert V Viswanathan said the top-up loans include loans against immovable assets (home loans), movable assets (vehicles and gold) and unsecured category based on income eligibility.
“The last category includes personal unsecured, micro finance and consumption loans. The top up is the gap between present outstanding and eligible loan amount. However, this exposes the lender to evergreening risk. The RBI says they may intervene in unsecured top up loans with regulatory measures to prevent identified risks in such loans,” he said.
Loan foreclosure charges
To safeguard customers’ interest through better transparency, the RBI is considering broadening the scope of regulations pertaining to “foreclosure charges/ pre-payment penalties on loans” to cover loans to micro and small enterprises. These enterprises may not be subject to foreclosure charges/ pre-payment penalties.
Currently, banks and NBFCs are not permitted to levy foreclosure charges/ prepayment penalties on any floating rate term loan sanctioned for purposes other than business, to individual borrowers with or without co-obligant(s).
