A framework for fair interest rates

There is a keen interest and hope that the RBI would lead with a structured framework that removes second-guessing what's fair in loan pricing

- SRINATH SRIDHARAN

THE DILEMMA SURROUNDING what constitutes a fair interest rate has been a long-standing debate in finance. For decades, regulators, lenders, and consumers alike have grappled with this complex issue.

While the core principle of fairness in lending is universally accepted, the parameters for defining "fairness" have remained elusive. The evolution of lending models, particularly with the rise of non-bank lenders, has added layers of complexity to this intricate discussion.

As the Reserve Bank of India (RBI) takes a more active role in addressing usurious lending practices, it is evident that consumer protection and transparency remain paramount. However, fairness in loan pricing is not merely about capping rates; it requires a formulaic approach that balances consumer interests with the sustainability of lenders.

The purpose of any lending institution is to serve its consumers, enabling access to credit that fosters growth, opportunity, and financial inclusion. But this mission cannot ignore business realities. Loan pricing is a multi-dimensional challenge.

Innovations in lending models have expanded access to credit, especially for underserved segments. Yet, these have brought complexity to the calculation of fair rates. Loan pricing encompasses various components, including interest rates, processing fees, contingent charges, and ancillary costs such as insurance. Lenders incur costs ranging from capital requirements to credit risk, operational expenses, write-offs for bad loans, and technological investments. If these costs cannot be reasonably recovered alongside a fair return on equity, lenders do not have purpose to stay in the market. As the American economist Milton Friedman once said, "The business of business is business."