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Business News/ Industry / Banking/  New RBI rules to regulate penal charges on loans to come into effect from next year. Seven things to know
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New RBI rules to regulate penal charges on loans to come into effect from next year. Seven things to know

RBI issues guidelines for penal charges in loan accounts to ensure transparency and credit discipline. The new rules will be effective from January 1, 2024.

The new rules would be applicable to all banking entities regulated by the RBI. (Mint)Premium
The new rules would be applicable to all banking entities regulated by the RBI. (Mint)

The Reserve Bank of India (RBI) has issued instructions for penal charges in loan accounts to ensure transparency in the disclosure of penal charges and interest rates in loan accounts. The guidelines with respect to penal charges in loan accounts will be effective from January 1, 2024.

“Under the extant guidelines, lending institutions have the operational autonomy to formulate Board approved policy for levy of penal rates of interest," RBI said in a notification on Fair Lending Practice - Penal Charges in Loan Accounts.

It has been observed that many Regulated Entities (REs) use penal rates of interest, over and above the applicable interest rates, in case of defaults / non-compliance by the borrower with the terms on which credit facilities were sanctioned, the central bank added.

The intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline and such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest, the central bank said.

RBI has issued the following instructions

1)Penalty, if charged, for non-compliance of material terms and conditions of the loan contract by the borrower shall be treated as ‘penal charges’ and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances. There shall be no capitalisation of penal charges i.e., no further interest computed on such charges. However, this will not affect the normal procedures for compounding of interest in the loan account.

2) The REs shall not introduce any additional component to the rate of interest and ensure compliance with these guidelines in both letter and spirit.

3)The REs shall formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called.

4)The quantum of penal charges shall be reasonable and commensurate with the non-compliance of material terms and conditions of the loan contract without being discriminatory within a particular loan/product category.

5) The penal charges in case of loans sanctioned to ‘individual borrowers, for purposes other than business’, shall not be higher than the penal charges applicable to non-individual borrowers for similar non-compliance of material terms and conditions.

6) The quantum and reason for penal charges shall be clearly disclosed by REs to the customers in the loan agreement and most important terms & conditions / Key Fact Statement (KFS) as applicable, in addition to being displayed on REs website under Interest rates and Service Charges.

7) Whenever reminders for non-compliance of material terms and conditions of the loan are sent to borrowers, the applicable penal charges shall be communicated. Further, any instance of levy of penal charges and the reason therefor shall also be communicated.

These instructions shall come into effect from January 1, 2024. REs may carry out appropriate revisions in their policy framework and ensure implementation of the instructions in respect of all the fresh loans availed/ renewed from the effective date. In the case of existing loans, the switchover to the new penal charges regime shall be ensured on the next review or renewal date or six months from the effective date of this circular, whichever is earlier.

The new rules would be applicable to all banking entities regulated by the RBI, including all commercial banks, co-operative banks, NBFCs, housing finance companies, and All India Financial Institutions like EXIM Bank, NABARD, NHB, SIDBI, and NaBFID. These instructions shall, however, not apply to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations which are covered under product-specific directions., the RBI said.

 

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ABOUT THE AUTHOR
Sangeeta Ojha
A business media enthusiast. Writes on personal finance, business and banking.
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Published: 18 Aug 2023, 10:01 AM IST
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