Monthly Archives: April 2016

Thursday Trivia – Buying a new car? Be wise – money wise.

                                              car-side
There is a very high probability that next generation especially in metro cities would not understand their day to day life without cars.  Right from being a luxury (when they were first invented) to becoming a necessity these days, cars have gone through a tremendous transformation in both its performance and availability.   Technology has played a very key role in past few decades. The rate at which the technology in the automobile industry has changed, it has enabled a low cost production with better features resulting into an attractive purchase price for people.
Also, the availability of loans over the past couple of decades has improved significantly, in order to facilitate the purchase of a car.  With the increase in number of banks offering better terms for loans, the power seems to now vest with consumers to negotiate better terms and conditions.  This has led to a series of problems which now a consumer faces.  With so many options available, it becomes difficult to first decide on which car to purchase.
But the major question still remains as to ‘how much money to spend while purchasing a new car?’
Usually, people demonstrate a very high level of emotions while purchasing their cars in India.  For them it’s not a just a mode of transport sitting in the parking lot, it’s a family member.  Also, there is a social proof in buying a car which demonstrates that a person is doing exceedingly well in their life.  Sometimes, that social proof is so high that even buying one car is not enough.  It’s a very sensitive topic to rationalise the financial decision making process in such cases.  But as a measure of practicality, let’s try to rationalise the financial decision making process while buying a new car.
The most popular thumb rule for buying a car is 20 / 4 / 10, which implies that a consumer should make a minimum 20% downpayment and the loan tenure should not be more than 4 years with expenditure (includes EMI, fuel cost and insurance) on a monthly basis should not cross more than 10% of the gross monthly income.
Another way to interpret this rule is that the cost of the car should not be more than 40% of the annual gross income of the consumer.
Let’s take an example of an individual whose gross annual income is Rs. 20 Lakhs which results in a gross monthly income of Rs. 1.66 Lakhs
Cost of car – Rs. 8 Lakhs (40% of 20 Lakhs)
Downpayment – Rs. 1,60,000/-
EMI – Rs. 16,232/- (interest @ 10%)
Tenure of Loan – 4 years
Hence, even without incurring any fuel cost, expenditure on EMI comes to 10% of gross monthly income.
Therefore it is advisable that the consumer should restrict the range of buying a car from 25% to at maximum 50% of gross annual income depending on how frugal to flamboyant a consumer is.
Also it is important for the individual to determine his / her priority in terms of saving for retirement and other important financial goals. In other words, consumer should spend on a car only after he / she has created an emergency fund and is saving enough to meet retirement and other important financial goals eg. children’s education.
Don’t go by the price tag and one-time tax levied on a car. These additional costs should also be added into calculations.
Interest on loan: Don’t forget to include the interest if you take a car loan. In the above example, total interest on loan comes to Rs. 1,40,00/-
Maintenance and repairs: After the first few free services, every visit to the service centre will cost you Rs 2,500-25,000, depending on whether you have an A-Star or a BMW.
Depreciation: This is the drop in the car’s value. The minute you drive out of the showroom, the value dips by 20%. No matter how well the car is kept, the value will dip by 15% every year, reducing the value of a Rs 5 lakh car to Rs 2 lakh in five years.
Image Courtesy : www.google.com

 

Thursday Trivia – Uniform KYC for all insurance policies

Earlier, insurance policies were issued in physical mode only, irrespective of whether a policyholder submits a proposal in physical form or online. Further, the policyholder was required to go to the respective Insurer’s office for all the policy servicing needs. Owing to this, the entire process was cumbersome, time consuming and involving incidental expenses. Since all the policies were issued in physical form and not usually collated at a single location, the matter got even more complicated on untimely demise of the policyholder. The dependents normally had hard time in identifying all the insurance policies and making claims with various insurance companies.

 

In order to overcome this difficulty and to collate and keep a safe custody of all the insurance policies of an individual at a single location, de-materialization of insurance policies is conceived. The insurance policies including the existing ones can be converted in an electronic form and held with an ‘Insurance Repository’. Activation of e-Insurance Account with Insurance Repository and all servicing would be offered ‘Free of cost’ to the policyholder.

 

Hence, the needs for a single point approach to Know Your Client (KYC) with the use of an online platform.

 

Insurance Regulatory and Development Authority (IRDAI) issued a circular in which it has instructed insurance companies to upload the KYC information of their policyholders on its platform – Insurance Transaction Exchange (iTrex) developed by IRDAI by April 20.

 

Currently, 10 insurance companies have uploaded the status of KYC on iTrex. In the circular, IRDAI has said, “It may be appreciated that the iTrex will not only facilitate aggregating data across insurers but also help in identifying duplicates within the insurers as is evident in the ongoing exercise. It is imperative to complete this exercise and make it up-to-date at the earliest. Data relating to KYC related details of insurance policies up to 31st March, 2016 also needs to be captured at an early date. For policies issued subsequent to 31st March, 2016, it is proposed to make the upload possible by web service.”

 

List of valid KYC documents:

o Identity Proof (Any One)

 PAN card

 UID

o Address Proof (Any One)

 Ration Card

 Passport

 Aadhar letter

 Voter ID Card

 Driving license

 Bank Passbook (not more than 6 months old)

 Verified copies of

  • Electricity bills (not more than 6 months old),
  • Residence Telephone bills
  • Registered Lease and License agreement /

 

Further, the insurance regulator has clarified that insurers who don’t comply to this circular cannot avail the benefits of iTrex. Currently, separate KYC is needed for different insurance policies. For instance, separate KYCs are required to buy a term insurance plan and a health insurance plan. Many insurance advisors feel that the existing complications in KYC norms are, to some extent, proving to be deterrent for new investors to buy insurance policies. This is a cause of concern for the insurance industry. To tackle this issue, IRDA had set up iTrex to facilitate data exchange between the repositories and insurance companies. A policyholder having an electronic Insurance Account (eIA) need not undergo multiple KYC.

 

IRDAI is planning to leverage iTrex to introduce uniform KYC in physical policies too. Earlier, T.S. Vijayan, IRDAI Chairman had said, “We are working on a project with Insurance Transaction Exchange (iTrex) to introduce uniform KYC in the insurance industry. This will help intermediaries in a big way.”

 

 

References:

  1. https://www.irda.gov.in/ADMINCMS/cms/frmGuidelines_Layout.aspx?page=PageNo2534

 

  1. http://www.policyholder.gov.in/uploads/CEDocuments/Insurance%20Repository%20System%20Handbook.pdf

Thursday Trivia – Use latest RBI guidelines to save interest on loans

Marginal Cost of funds-based Lending Rate (MCLR)
On December 17, 2015, The Reserve Bank of India (RBI) had issued final guidelines on computing interest rates on advances based on the marginal cost of funds to come to effect on April 1, 2016.
The Indian banking sector has struggled through a number of rate-setting methods over the last few years and has moved from a benchmark prime lending rate (BPLR) system to a base rate (or minimum lending rate) system and now the marginal cost of funds-based lending rate (MCLR).
As per MCLR, every bank will be required to calculate its marginal cost of funds across different tenors. To this, the banks will add other components including operating cost and a tenor premium.
Currently, the banks are slightly slow to change their interest rate in accordance with repo rate change by the RBI. Commercial banks are significantly depending upon the RBI’s Liquidity Adjustment Facility (LAF) repo to get short term funds. But they are reluctant to change their individual lending rates and deposit rates with periodic changes in repo rate. Whenever the RBI is changing the repo rate, it was verbally compelling banks to make changes in their lending rate.
An observation can be made that, RBI has cut interest rates to the tune of 150 basis points in this fiscal year. But, this has not been effectively transmitted to lending rates offered by banks. Banks has so far lowered their base rate by only 50 – 60 basis points.
The purpose of changing the repo rate is realised only if the banks are changing their individual lending and deposit rates.
The key element of the MCLR system is that it facilitates the monetary transmission. It is mandatory for banks to consider the repo rate while calculating their MCLR. Previously under the base rate system, banks were changing the base rate, only occasionally. They waited for long time or waited for large repo cuts to bring corresponding reduction in their base rate.
Now with MCLR, banks are obliged to readjust interest rate monthly. This means that such quick revision will encourage them to consider the repo rate changes.
Calculation of MCLR
‘Marginal’ means the additional or changed situation. While calculating the lending rate, banks have to consider the changed cost conditions or the marginal cost conditions. For banks, what are the costs for obtaining funds? It is basically the interest rate given to the depositors (often referred as cost for the funds).
The MCLR norm describes different components of marginal costs. A novel factor is the inclusion of interest rate given to the RBI for getting short term funds – the repo rate in the calculation of lending rate.
Following are the main components of MCLR:
1. Marginal cost of funds;
The marginal cost of funds will comprise of Marginal cost of borrowings and return on net worth. According to the RBI, the Marginal Cost should be charged on the basis of following factors:
a. Interest rate given for various types of deposits- savings, current, term deposit, foreign currency deposit
b. Borrowings – Short term interest rate or the Repo rate etc., Long term rupee borrowing rate
c. Return on net worth – in accordance with capital adequacy norms.
2. Negative carry on account of CRR;
It is the cost that the banks have to incur while keeping reserves with the RBI. The RBI is not giving an interest for CRR held by the banks.
The cost of such funds kept idle can be charged from loans given to the people.
3. Operating costs;
It is the operating expenses incurred by the banks
4. Tenor premium.
It denotes that higher interest can be charged from long term loans.
The marginal cost of borrowings shall have a weightage of 92% of Marginal Cost of Funds while return on net worth will have the balance weightage of 8%.

RBI’s key guidelines on MCLR

• All loans sanctioned and credit limits renewed w.e.f April 1, 2016 will be priced based on the Marginal Cost of Funds based Lending Rate.
• MCLR will be a tenor-based benchmark instead of a single rate. This allows banks to more efficiently price loans at different tenors based on different MCLRs, according to their funding composition and strategies.
• Banks have to review and publish their MCLR of different maturities every month on a pre-announced date.
• The final lending rates offered by the banks will be based on by adding the ‘spread’ to the MCLR rate.
• Banks may specify interest reset dates on their floating rate loans. They will have the option to offer loans with reset dates linked either to the date of sanction of the loan/credit limits or to the date of review of MCLR.
• The periodicity of reset can be one year or lower.
• The MCLR prevailing on the day the loan is sanctioned will be applicable till the next reset date.
• Existing borrowers with loans linked to Base Rate can continue with base rate system till repayment of loan. An option to switch to new MCLR system will also be provided to the existing borrowers.
• Once a borrower of loan opts for MCLR, switching back to base rate system is not allowed.
• Loans covered by government schemes, where banks have to charge interest rates as per the scheme are exempted from being linked to MCLR.
• Like base rate, banks are not allowed to lend below MCLR, except for few categories like loans against deposits, loans to bank’s own employees.
• Fixed Rate home loans, personal loans, auto loans etc., will not be linked to MCLR.

Advantages
With the inclusion of shorter term MCLR rates, banks can compete with the commercial paper market as well moving towards international standards. Will reduce the cost of borrowing for companies. Will make the lending rate framework more dynamic as different banks could have different MCLRs for different tenures.

Disadvantages
Banks have been given the option to keep outstanding loans linked to the base rate system even though it said existing borrowers will also have the option to move to an MCLR linked loan “at mutually acceptable terms.”
Most banks are unlikely to offer this option easily as it means that any immediate hit to profitability may be avoided.
Certain loans such as those extended under government schemes or under restructuring package, advances to banks’ depositors against their own deposits, loans to banks’ own employees including retired employees and loans linked to a market-determined external benchmark will be exempt from the MCLR rule.

Conclusion
As per the guidelines, MCLR will be automatically applicable on fresh loans extended by the bank. Whereas, existing loan holders have a choice to either stay with original BPLR framework or convert into MCLR framework.
Since MCLR is directly regulated by RBI, it is more beneficial for existing loan holders to convert as they won’t have to be completely dependent upon workings of a banks base rate. Even, transmission of any rate cut announced by RBI will be easily accessible at the reset date. MCLR is a far more convenient and beneficial option.
References:
RBI Press Release – https://rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=35749
RBI Guidelines on December 17, 2016 – https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=10179&Mode=0