The Reserve Bank of India is actively considering prescribing a benchmark rate for home loans.

This is because many banks are throwing caution to the wind and dropping lending rates on home loans below their prime lending rates.

In the annual report 2003-04, the central bank expressed concern as banks have reduced lending rates to such an extent that they are almost lending without any margin over their cost of funds.

The RBI has cautioned banks to be on the alert against unbridled growth of housing finance. Banks should take precaution in the matter of interest rates, margin, reset period and documentation, warned the central bank.

"The interest rate on home loans is hovering in a range of 7.5-9.75 per cent, which is higher than the interest rate on longer term deposits of commercial banks by 1.5-3.75 per cent," said the central bank.

Housing finance serves the dual purpose of leading recovery and providing a safe avenue for bank assets during periods of industrial slow down.

The housing sector provides a safe destination for bank credit on account of lower than average rates of default in housing finance.

This explains the surge in bank finance to the housing sector with credit flows rising by 55 per cent in 2002-03.

RBI's report stated that housing loans extended by banks stood at 6.1 per cent of non-food gross bank credit as on March 2003, compared with 3.8 per cent at the end of March 2001, and 4.6 per cent in March 2003.

"The growth of housing finance is expected to increase at much higher rates in the years ahead," stated the central bank.

Though RBI has cautioned banks against lowering interest rates on home loans, the central bank itself had initiated a host of supply side measures to boost inflow of bank credit to the housing sector and ensure the benefit of soft interest rates to borrowers.