RBI proposes scrapping foreclosure charges on loans for THESE borrowers; Will this ease loan burden?

The Reserve Bank of India (RBI) released draft norms for prepayment penalties on loans on Friday, February 21, where it proposed to scrap the foreclosure charges on floating-rate loans for retail and MSME borrowers. Once approved, this will apply to all floating-rate loans. The central bank added that the loans granted for business purposes to individual borrowers will also be free of the existing foreclosure or prepayment penalties. 

The current penalty on personal loans for retail borrowers is 4-5 per cent of the outstanding principal. “In terms of extant instructions, certain categories of Regulated Entities (REs) are not permitted to levy foreclosure charges/ pre-payment penalties on the floating rate term loans sanctioned, for purposes other than business, to individual borrowers with or without co-obligate(s),” said the RBI in its draft norm instructions released today.

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RBI's draft norms on foreclosure charges to ease loan burden?

The guidelines will apply to eligible loans foreclosed on or after a date to be indicated in the final circular. Last year, the RBI had said that it would release a draft circular on foreclosure charges of loans as banks and non-banking financial companies (NBFCs) are not allowed to levy foreclosure charges or pre-payment penalties on any floating rate term loan sanctioned to individual borrowers with or without co-obligates for purposes other than business.

The draft norms also said that other than Tier 1 and Tier 2 Primary (Urban) co-operative banks and base-layer NBFCs shall not levy any charges/ penalties in case of foreclosure/ prepayment of floating rate loans granted to individuals and MSE borrowers, with or without obligate (s), for business purposes. However, in the case of MSE borrowers, these instructions shall be applicable up to the aggregate sanctioned limit of ₹7.50 crore per borrower.

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The draft norms also stated that lenders should permit foreclosure/ pre-payment of loans without stipulating any minimum lock-in period for MSME and retail borrowers. Lenders shall not levy charges/ penalties in cases where prepayment is effected at the instance of the lenders. "The applicability or otherwise of foreclosure charges penalties shall be appropriately mentioned in the Key Fact Statement 3 for applicable loans and advances," said RBI.

According to the norms, lenders will not levy any retrospective charges at the time of foreclosure/ prepayment of loans that were waived by the lenders and not disclosed in advance to the borrowers under any circumstance. This is to safeguard customers' interests through transparency and customer-centricity by the lenders. It also seeks to broaden the scope of such regulations to cover loans to MSMEs.

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RBI's supervisory reviews have indicated divergent practices among REs regarding the levy of foreclosure charges/ pre-payment penalties in cases of loans sanctioned to MSEs, which lead to customer grievances and disputes. The central bank has invited comments from stakeholders by March 21, 2025.