RBI issues draft guidelines for penalty charges on loan accounts
- RBI said that penal charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest.
Reserve Bank on Wednesday has issued various guidelines to regulated entities (REs) to ensure reasonable and transparency in disclosure of penalty interest.
Under the guidelines, lending institutions have the autonomy to formulate board approved policy for levy of penal rates of interest.
However, RBI said it has been observed that many REs use penal rates of interest, over and above the applicable interest rates, in case of defaults or non-compliance by the borrower with the terms on which credit facilities were sanctioned.
RBI, in its draft said that the intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline among borrowers through negative incentives and to ensure fair compensation to the lender.
It said that penal charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest.
However, supervisory reviews have indicated divergent practices amongst the REs with regard to levy of penal interest/charges leading to customer grievances and disputes.
The central bank said that determination of interest rates on credit facilities, including conditions for reset of interest rates, will be strictly governed by the relevant regulatory instructions issued and ‘REs shall not introduce any additional component to rate of interest.’
It added that penalty, if charged, shall be treated as ‘penal charges’ and not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances.
“It needs to be recognised that the rate of interest on a loan includes appropriate credit risk premium reflecting the credit risk profile of the borrower. If the credit risk profile of the borrower undergoes change, REs will be free to alter credit risk premium as per the contracted terms and conditions, in terms of extant instructions,” said RBI.
The central bank said that 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 nonindividual borrowers.’