Previous Year Question
Why is the offering of ‘teaser loans’ by commercial banks a cause of economic concern?
The ‘teaser loans’ are considered to be an aspect of sub-prime lending and banks may be exposed to the risk of defaulters in future.
In India, the ‘teaser loans’ are mostly given to inexperienced entrepreneurs to set up manufacturing or export units.
Which of the statement(s) given above is/are correct?
Only 1
Only 2
Both 1 and 2
Neither 1 nor 2
Correct Answer: A
Detailed Solution
A teaser loan is a loan offered at a comparatively low interest rate for an initial period. After the specified introductory period ends, the interest rate resets to a higher or prevailing floating rate.
For example, a housing loan may carry a low rate for the first two or three years and subsequently become linked to the bank’s normal floating rate. The borrower’s EMI may then rise significantly.
Statement 1 is correct. The principal concern is that loan eligibility and repayment capacity may be assessed using the low introductory rate. When the interest rate and EMI subsequently increase, some borrowers may be unable to meet the higher repayment obligation.
This can create:
A greater probability of future loan defaults
An increase in banks’ Non-Performing Assets
Incorrect assessment of the borrower’s long-term repayment capacity
Instability in housing or other asset prices
A risk that borrowers may mistake the introductory rate for a permanent rate
RBI consequently treated teaser-rate housing loans as carrying higher risk than ordinary housing loans. In December 2010, the standard-asset provisioning requirement for such housing loans was raised to 2 per cent. Normal provisioning could apply after the rate was reset and the account remained standard for the prescribed period.
Teaser loans were associated with sub-prime-type risk because low introductory rates could attract borrowers who might not be capable of servicing the higher future EMI.
Statement 2 is incorrect. Teaser loans in India were not primarily loans granted to inexperienced entrepreneurs for establishing manufacturing or export units. The expression became particularly associated with housing loans and certain other retail-credit products offered at low introductory rates.