RBI’s Proposal for Prepayment Fee Ban: An Indirect hit to NBFCs and Banks

In a move that is expected to reshape the lending landscape, the Reserve Bank of India (RBI) has proposed the removal of foreclosure charges on floating-rate loans for small businesses and individual borrowers. While this decision aims to benefit consumers, it is likely to have a more profound impact on Non-Banking Financial Companies (NBFCs) than on traditional banks. This blog explores the consequences of the RBI’s decision and its potential implications for the retail loan market, MSMEs, and the competition between Banks and NBFCs.

The Impact on NBFCs:

NBFCs, which are primarily involved in lending to small businesses and the retail segment, will feel the brunt of this RBI move. These institutions rely significantly on income generated from prepayment charges. As per the IIFL report, prepayment charges can account for a substantial portion of their profitability. With the removal of this fee, NBFCs will face a sharp reduction in income from the loans they offer, particularly in the retail loan against property (LAP), SME, and business loan sectors.

A key reason why NBFCs will be more impacted than banks is the fact that they have a larger share of their assets under management (AUM) invested in these segments, making them more vulnerable to any shifts in income streams. For instance, Many NBFCs have about 25% & more of their AUM in floating-rate MSME and LAP loans, which are directly impacted by the prepayment ban. In contrast, banks such as Axis, IndusInd, and Kotak Mahindra also rely on prepayment fees, but their overall reliance on this income is somewhat lower compared to their NBFC counterparts.

A New Era of Competition in Retail Loans:

The removal of prepayment charges is likely to introduce even greater competitiveness within the retail loan market – especially for floating rate loans. Without a penalty for early repayment, consumers can effortlessly change lenders, and in search of better rates, making it imperative for banks and NBFCs to roll out competitive pricing or enticing loan terms. Such competitiveness, however, could result in reduced profitability for both NBFCs and banks, as the competition makes the margins tighter.

Larger NBFCs, which are generally well capitalized, may avoid affordable housing finance companies as they are more likely to compete on rates. As these markets become over saturated, smaller players might find it difficult to stay consistently profitable, especially if they cannot manage their costs of funds.

How MSMEs will be benefited?

Such regulatory movement can be advantageous particularly for Micro, Small, and Medium Enterprises (MSMEs), as removing prepayment charges gives them the options to refinance their loans without incurring penalties. This new strategy will allow MSMEs to be more agile in dealing with lenders, which will certainly lead to a more favorable outcome for them. In all, MSMEs will enjoy higher cash flow in a scenario where the business environment is indeed very turbulent.

Favorable loans terms are significant for MSMEs because they enable the repayment of loans without incurring any penalties, resulting in facilitating the reinvestment of funds back into the business. This will help MSMEs enjoy a lower interest burden and greater liquidity which will allow them to flourish in a competitive environment.

How Banks and NBFCs Will Adapt to the Change?

• The removal of prepayment fees is uncertain, One solution might be putting greater focus on customer relations and increasing loan retention by making them less appealing to prepayment or refinancing.
• Banking and NBFCs might use other financial products such as insurances to offset the income that will be lost due to prepayment fees.
• More reputable NBFCs may be able to take advantage of balance transfer competition and win over previously difficult to reach high yield clients.
• This could reduce the negative impact of a prepayment fee ban on their profit, all the while pumping more money into their advertising campaigns.

Loan Bazaar’s View :

We see this move has a positive economic impact from both a customer and broader economic perspective. This will support economic growth and improving financial well-being. Customers will feel more valued and respected, as they won’t be penalized for paying early. This can foster stronger customer loyalty and a positive brand perception. Customers can save money by avoiding unnecessary fees, helping to reduce the overall cost of services or products. Encouragement of Early Payments Without the financial deterrent of fees, customers may be more inclined to pay off debts or balances sooner, which can improve cash flow for the business.

Conclusion:

At Loan Bazaar we see this RBI’s decision to ban prepayment fees is a clear attempt to benefit consumers, especially MSMEs, by providing more flexibility and reducing financial burdens. However, the ripple effect of this move will hit NBFCs harder than banks, given their higher exposure to floating-rate loans in the MSME and retail sectors. As competition intensifies, both banks and NBFCs will need to adapt quickly by rethinking their pricing strategies, improving their service offerings, and exploring new avenues of profit generation. While the prepayment fee ban presents challenges, it also offers opportunities for innovation and customer-centric solutions in the ever-evolving lending space.

For MSMEs, this is a significant opportunity to explore more competitive loan options, reduce debt burdens, and ensure the long-term growth of their businesses. For lenders, the road ahead may be challenging, but with the right strategies in place, they can turn this change into a chance for growth and market dominance. This move by RBI signals a shift in the Indian lending landscape towards more customer-friendly policies, potentially leading to long-term improvements in the financial ecosystem for both businesses and individual borrowers.