RBI proposes internal ceilings on how much small borrowers pay on loans

Mumbai: The Reserve Bank of India (RBI) proposed changes to how banks and non-banks calculate interest rates, saying that lenders should cap costs for small loans taken by borrowers and microfinance customers.

It proposed that lenders put a ceiling on the annual percentage rate on microfinance loans and small value loans and ensure that they are not usurious. The central bank defines the annual percentage rate as the annual cost of credit to the borrower, which includes the interest rate and all other charges.

A personal loan of up to ₹50,000 taken by an individual would be classified as a small value loan.

According to a microfinance sector executive, lenders at present have an interest rate range that they charge borrowers and not a ceiling on the annual percentage rate.

The RBI’s proposals released on Wednesday, when finalized, will be applicable to banks, non-banking financial companies, mortgage lenders, cooperative banks and all-India financial institutions. It said these lenders should have a comprehensive policy on interest rates on loans and advances, approved by the board of directors. The policy should include matters related to pricing of loans, including microfinance loans.

“Such aspects shall, inter alia, include the methodology for determining interest rates, including defining the internal benchmark, the components of the spread, the loan categories, and the delegation of powers for loan pricing. The policy shall be reviewed at least annually,” it said.

On Wednesday, the RBI said that it has come across divergent practices in certain aspects of loan pricing at banks, including determination of the marginal cost of funds-based lending rate (MCLR) and its components. In addition, the current guidelines contain very limited regulatory instructions regarding fixed rate loans, it said.

Transparent dealings

The central bank has cautioned non-banks against charging unsustainable interest rates to borrowers. Deputy governor Swaminathan J said in April 2025 that the NBFC sector must live up to its promise of inclusion by treating customers with dignity, transparency and care.

“This entails ensuring transparent and easy-to-understand pricing, free from hidden charges or usurious interest rates,” he had said.

A plan to bring clarity on the setting of interest rates was first announced by governor Sanjay Malhotra on 5 August. Malhotra clarified that the move should not be misunderstood to mean there will be changes in loan repayments or equated monthly installments. This is an initiative to understand interest rates transparently and the principles that govern them, he emphasized.

In its draft guidelines on Wednesday, the RBI said a lender should determine the interest rate on a fixed rate loan with reference to its internal benchmark or an external benchmark, plus a risk-based spread. It said lenders must not price loans below the applicable benchmark.

For floating rate loans — where interest rates change in tandem with the benchmark — the RBI wants lenders to determine the interest rate according to internal benchmarks or external benchmarks, plus a risk-based spread. As is the case with fixed rate loans, the RBI said lenders cannot price a loan below the associated benchmark.

Marginal cost of funds

The regulator said the internal benchmark for a commercial bank and other lenders with total deposits of more than ₹1,000 crore should be based on the marginal cost of funds.

“Marginal cost of funds shall be calculated as a moving average of the marginal costs of domestic deposits and borrowings for the bank during the trailing three-month period,” it said.

These lenders will have to publish the internal benchmark on the first calendar day of each month, which shall be applicable to all loans and advances linked to the benchmark and sanctioned during that month.

As is the case at present, the RBI said banks will link all floating rate loans taken by individuals and small businesses to an external benchmark.