RBI Initiates New Guidelines For Loan Penal Charges To Boost Transparency & Fair Practices
The Reserve Bank of India (RBI) has introduced guidelines concerning penal charges on loan accounts to enhance transparency in disclosing these charges and interest rates. The regulations pertaining to penal charges on loan accounts will become effective from 1 January 2024.
The RBI notification on Fair Lending Practice - Penal Charges in Loan Accounts stated that as per current guidelines, lending institutions possess operational independence to create a Board-approved policy for imposing penal rates of interest.
The central bank highlighted that many Regulated Entities (REs) impose penal rates of interest, in addition to the applicable interest rates, in situations of borrower defaults or non-compliance with the terms of credit facility approval.
The central bank clarified that the purpose of levying penal interest/charges is primarily to foster credit discipline and should not be utilised as a means to generate additional revenue beyond the contracted interest rate.
The RBI has issued the following directives:
Penalties for borrower non-compliance with significant loan contract terms will be considered 'penal charges' and should not be imposed as 'penal interest' added to the interest rate on advances. Capitalisation of penal charges, i.e., calculating further interest on these charges, will not occur. However, standard procedures for interest compounding in the loan account will remain unaffected.
Additional components should not be introduced to the interest rate by REs. They must ensure compliance with these guidelines in both word and spirit.
REs are required to create a Board-approved policy on penal charges or similar charges for loans, under any nomenclature.
The quantum of penal charges must be reasonable and proportional to the non-compliance with significant terms and conditions of the loan contract, devoid of discrimination within a specific loan/product category.
Penal charges for loans provided to 'individual borrowers, for non-business purposes,' should not exceed the penal charges for non-individual borrowers facing similar non-compliance.
REs must transparently disclose the quantum and rationale behind penal charges to customers in the loan agreement, vital terms and conditions, and Key Fact Statement (KFS), along with making this information available on their websites under Interest rates and Service Charges.
Whenever reminders regarding non-compliance with significant loan terms are issued to borrowers, the associated penal charges must be communicated. Instances of penal charge imposition and the reasons for it should also be communicated.
These directives will take effect from 1 January 2024. REs should adjust their policy frameworks accordingly and ensure implementation of these guidelines for all new loans acquired or renewed from the specified date. For existing loans, the transition to the new penal charges system should take place during the subsequent review or renewal date, or within six months from the circular's effective date, whichever is earlier.
The new rules will be applicable to all banking entities regulated by the RBI, encompassing commercial banks, co-operative banks, NBFCs, housing finance companies, and All India Financial Institutions like EXIM Bank, NABARD, NHB, SIDBI, and NaBFID. However, the RBI clarified that these instructions will not apply to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations covered by product-specific guidelines.
