Individuals wanting personal loans now have to compensate banks for the regulatory requirement of having to make higher provisioning for these loans and also for the even greater risk of interest rates rising further.

The compensation will be in the form of higher interest rates. One part of the rise will be equivalent to the hit the lender takes on its bottom line on account of higher provisioning and the other to provide the lender a cushion for increase in cost of funds.

The compensation equal to the provisioning will be 1 percentage point, while the cushion for the risk of further increase in cost of funds will be 1-2 per cent.

The Reserve Bank of India has doubled the provisioning on standard personal loans and credit card receivables to 2 per cent from 1 per cent. This means on a Rs 100 personal loan or credit card receivable, banks will have to deduct Rs 2 (instead of Rs 1 earlier) from operating profit.

Personal loans are given at a fixed rate of interest for terms ranging from one year to five years, but the lending bank faces the risk of rise in cost of resources during the tenure of the loan and, hence, the extra topping of interest.

So, the increase in interest rates on personal loans will be at least 2-3 per cent. This marks the end of an over three-year period when personal loans were available at 11-12 per cent for prime customers, like employees of blue-chip companies.

The interest rate range on personal loans will increase from 11-20 per cent to 13-23 per cent. Individual borrowers will also no longer be treated with freebies such as a wristwatch.

Credit card dues

In the case of rolled-over credit card dues, banks already charge interest rates as high as 24-36 per cent. Banks are currently considering whether they need to hike the interest rate charged on credit card overdues.

The highest interest rate charged on credit card rollovers could touch 40 per cent, if banks decide to jack up rates on credit card receivables. The decision will be based on the defaults being experienced.

Defaults in both personal loans and credit card receivables are estimated to be around 15 per cent. Banks will decide to raise the already high interest rates on credit card receivables the moment loan defaults begin to rise.

Individual borrowers also pay for defaulters as banks take a view on interest rates on every product -- be it personal loans or home loans -- going by their experience on defaults.

Banks keep interest rates at a level that ensures payments by good customers cover for the defaults by a section of borrowers.

Banks have been witnessing increasing defaults in personal loans and credit card receivables categories and this could prove to be very expensive for good borrowers, who have to pay up (read 'pay dearly') for the sin committed by bad borrowers.

RBI-speak

• Early warning signals emanating from rising inflation indicate that Monetary Policy is still accommodative, warranting a policy response in terms of a measured increase in interest rates to assuage demand pressures.
• The continued high credit growth in the real estate sector, outstanding credit card receivables, loans and advances qualifying as the capital market exposure and personal loans, is a matter of concern. It has, therefore, become imperative to increase the provisioning requirement for these standard assets (excluding residential housing loans) to 2 per cent from 1 per cent.