Q. 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 statements given above is/are correct? (UPSC Prelims 2011)
Answer:
1 only
Notes: The correct answer is
1 only. Teaser loans (also known as step-up loans) are a specific type of credit product where the interest rate is kept artificially low for the initial few years of the loan tenure to "tease" or attract borrowers.
- Sub-prime Risk (Statement 1 is Correct): Teaser loans are often linked to sub-prime lending because they can attract borrowers who might not be able to afford the loan once the "teaser" period ends and interest rates reset to a much higher market rate. This creates a significant risk of default in the future. If a large number of borrowers default simultaneously when rates go up, it can lead to a systemic financial crisis, similar to what was seen during the Global Financial Crisis of 2008.
- Target Audience (Statement 2 is Incorrect): In India, teaser loans were primarily offered in the housing sector (home loans) to individual retail borrowers, rather than to "inexperienced entrepreneurs" for manufacturing or export units. The Reserve Bank of India (RBI) expressed concern over these loans because they felt banks were not adequately assessing the long-term repayment capacity of homeowners.
- RBI's Stance: Because of the inherent risk, the RBI increased the provisioning requirements for teaser loans, making it more expensive for banks to offer them. This was done to ensure banks had enough capital cushioned against potential future defaults.