The 0% EMI scheme is viewed as a great benefit by most consumers. However, this method of repayment consists of a shorter tenure and hidden costs. The lender receives more than the regular interest rate from the borrower and the overall expense of the loan/ credit is higher than what is initially perceived. Recognizing this issue as well as various other factors and to protect consumers, the RBI has placed a ban on this EMI scheme. This is intended to ensure transparency is the pricing mechanism.
Example: Person “A” buys a phone worth Rs. 40,000 at 0% interest on EMI for a period of 6 months. EMI amount is Rs. 6,667. The processing fee is Rs. 1600 and by paying the EMI for 6 months only, the borrower is effectively paying a flat rate of interest. This means that the interest will be calculated on the full loan/ credit amount and not based on the reducing balance method. Hence, person “A” would effectively be paying a 14.15% interest, unknowingly. Whereas, if he had purchased the mobile in cash he would have received a discount on the same. Alternatively, if he had purchased on an EMI at a regular rate of interest he would only have to pay a 10- 12% interest (depending on the lender).
Factors Leading to RBI Ban on 0% EMI Scheme
The following factors contributed to the decision of RBI to ban the 0% interest on EMI scheme:
- Hidden Rate of Interest: Even though the scheme claims that there is 0% interest charged on the EMI, other charges make up for the interest component. It is mostly retrieved in the form of processing fee. This indicates that the scheme is using false claims to attract borrowers and exploiting the opportunity. Most banks are not allowed to offer loans below the stipulated Base Rate.
- Artificial Demand Creation: Sales were higher due to this 0% interest on EMI scheme. This lead to artificial inflation of demand through purchases driven by sentiment. The ultimate consequence of this would be an economy with low growth and high rate of inflation. Once the 0% EMI schemes were banned, the sale of a lot of high-end consumer goods have declined.
- Disparity in Pricing: The price of a product varies depending on the mode of payment – whether the payment is made via debit card, cash or credit card. Usually, the customer receives a discount when he/she opts for upfront payment in cash, for the product. This benefit is not offered to those who opt for an EMI scheme for repayment. Merchants also levy a transaction fee on those who wish to pay by debit/ credit card. Such pricing disparity also proved to be a major problem under the 0% EMI scheme.
EMI repayment is a boon for those who wish to own long-term assets like a home, education, etc. These also offer benefits in the form of tax exemption. However, when EMI scheme is used for purchasing products with depreciation value like cars, gadgets, etc. the overall benefit is much lower. Added to this equation, the 0% EMI scheme makes the customer spend more and enter into a higher debt crisis. Based on all these factors that would negatively affect the customers as well as the economy, RBI has banned the 0% EMI scheme.
Effect of the ban of 0% EMI scheme
In order to create social awareness, RBI has notified banks and retailers to offer uniform interest rates and equated processing fees for selling any product to customers. RBI has also directed the banks to make customers fully aware of the benefits offered by the manufacturers during a festive sale. This move is directed to keep banks from taking advantage of the ignorance and sentiments of the customers and earning benefits in return. There are significant effects visible among customers as well as companies and banks.
On the customers
With minimal understanding of the 0% EMI scheme and the benefit of buying the product without even having money through credit cards, customers actually tend to pay more interest than a normal EMI scheme while buying any product from retailers. So, the RBI’s move is beneficial for customers as unknowingly they get trapped into such rampant schemes where the debt amount becomes a lot higher than normal. This move has definitely created a strong awareness among the customers about the hidden factors of such unhealthy schemes.
On the companies
With the ban of 0% EMI scheme, the consumer goods manufacturers and banks in the country are a little on the back foot. A report says about 20-30% of the sale of consumer goods such as TVs and other gadgets take place through 0% EMI schemes during the festive season offer periods. The sale percentage has fallen down after the RBI notification. Customers have become more sensible to opt for such schemes by keeping their sentiments aside.
On the economy of the country
With the downfall of the sale of consumer goods, the overall sale has also been affected which, of course, affects the national economy. However, in the long run, it foreshadows a positive change since consumers can now take informed decisions without being misled by the banks. Customers can differentiate the need that is driven by sentiment and the need of an actual requirement of any product. This will restrict the demand to some extent and control the inflation rate which will ultimately lead to the growth of the Indian economy in the long run.