Banking News

Understanding no-cost EMI and its implications

Republic Day sale is here and so are the finance schemes including no cost EMIs and BNPL (Buy Now Pay Later). A closer look reveals no cost EMI plans tout 0% interest, but this claim is overshadowed by concealed charges, particularly processing fees. The RBI highlighted zero percent EMI schemes in 2013 for misleading practices and violations of fair pricing standards. We explore the hidden charges and growth in the segment.

What is “no cost EMI”?
No Cost EMI, also known as zero cost EMI or interest-free EMI, is a financing option where the cost of a product can be converted into Equated Monthly Installments (EMIs) without incurring additional charges beyond the agreed purchase price. It’s widely available at various online and offline stores.

During the October 2023 Great Indian Festival sale, one out of four purchases made were through EMI and three out of four products were sold through no-cost EMIs, according to Amazon. While no cost EMI may seem attractive, consumers should be aware of potential processing fees and hidden costs.

How is it priced?
No Cost EMI schemes claim 0% interest, but hidden charges like processing fees reveal otherwise. In 2013, the Reserve Bank of India warned against such schemes for violating fair pricing practices. The term “No Cost EMI” is misleading as interest costs are embedded, visible or not. Manufacturers and merchants, not consumers, bear these costs, impacting their margins. Some deals may lack upfront payment discounts, affecting buyers. Zero percent EMI on credit card outstandings often conceals interest in processing fees.

The cost is built into the EMI, though the breakdown may not be immediately visible. This can affect the overall cost of the product, with sellers often absorbing the interest component to attract more buyers.

What has RBI done to raise awareness and ensure fair practices?
Again in April 2022, the Reserve Bank of India (RBI) asked lenders to maintain transparency in converting credit card transactions to EMIs. It urged card issuers to clearly indicate the principal, interest, and upfront discounts before conversion. RBI has been asking for disclosures to prevent the camouflaging of interest as zero-cost EMI.In the past RBI has found instances where merchants have levied a fee as a percentage of the transaction value as charges on customers who are making payments for purchase of goods through debit cards. Calling these fees “not justifiable” as per the bilateral agreement between the acquiring bank and the merchants, RBI had asked for termination of the relationship of the bank with such merchants. Previously, RBI had highlighted that for retail products, the rate of interest is typically kept uniform and not based on individual customer’s risk profile. Some banks also were earlier including the expenses incurred in loan sourcing, like DSA commission, in the rate of interest applied to the product.

How do NBFCs and banks benefit from no cost EMI?
Lenders benefit from fee income, with consumers availing discounts through EMI options, even with a processing fee. The finance cost is embedded in the product’s selling price, allowing sellers to increase sales volume. While sellers offset the rising interest rates by increasing product prices, consumers enjoy liquidity and reward points.

How does RBI’s increased risk weight on unsecured loans affect no cost EMIs?
RBI’s raised risk weight on unsecured loans, including personal and retail loans, impacts no cost EMI schemes as higher risk weights may lead to increased interest rates on these loans, affecting sellers who may raise product prices to maintain net realisations.

What happens when one opts not to use a finance scheme like this?
Opting out of a finance scheme means accepting the interest built price as the effective selling price.

Going forward, when it comes to retail products, the interest rates which are generally flat and do not vary based on the customer’s risk profile should be based on their credit score.

Source link