Low rates in initial years may cause Indian sub-prime

Some of the Indian banks are these days offering home loans that have very low rate of interest in beginning and is linked to benchmark prime lending rate (BPLR) at a later stage. For example, the State Bank of India (SBI) under a new scheme is offering home loans, which have as interest rate as low as 8% in first year that increases to 8.5% and to 9% over the next two years. Therefrom the rate is linked to the BPLR.

While the basic idea behind the move is to generate greater housing demand in the short term to push the economy, which is still suffering from the after-effects of global financial crisis and has slowed down to a 5 year low in terms of growth, such policies if practiced indiscriminately, may also generate a sub-prime crisis like situation in the Indian housing market.

The main reason pointed out by most economists for the sub-prime crisis in the US, which later led to the global financial collapse and world economic downturn, was banks’ offering of lower interest rates for an initial period that led to a lot of people buying unaffordable homes. Once the initial period was out, loan takers were unable to pay instalments, leading to increasing delinquencies and rising non-performing assets (NPA) of banks.

While the scenario is not similar in the Indian case, the argument remains same. The lower interest rate for initial period inherently assumes that economy will improve going forward and therefore the ability to pay will improve, too. However, in case the global recession proves to be a double dip one, as is being expected by some quarters, at least some of the people availing loans may find it difficult to repay, thus creating a potential of rising NPAs of banks.