RBI: The Reserve Bank of India (RBI) has released directives pertaining to penalties applied to loan accounts, aiming to enhance transparency in revealing both penal charges and interest rates within such accounts. These guidelines concerning penal charges within loan accounts are slated for implementation starting January 1, 2024.
RBI issues new notification on penal charges
In a notification pertaining to the charges, RBI stated, “Under the extant guidelines, lending institutions have the operational autonomy to formulate Board approved policy for levy of penal rates of interest.” The central bank noted that numerous Regulated Entities (REs) employ additional rates of interest, known as penal rates, in instances of borrower defaults or non-compliance with the terms under which credit facilities were originally approved.
The central bank clarified that the purpose behind imposing penal interest/charges is primarily to foster a culture of credit discipline. These charges are not intended to function as a means of increasing revenue beyond the agreed-upon interest rate, as emphasized by the central bank.
The upcoming regulations will extend to all financial institutions under the purview of RBI’s regulation, encompassing commercial banks, co-operative banks, NBFCs, housing finance companies, and esteemed entities like EXIM Bank, NABARD, NHB, SIDBI, and NaBFID. However, it’s important to note that these guidelines will not be applicable to specific products such as Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations, which are subject to their own distinct directives, as stated by the RBI.
Seven key points on RBI’s update
1. In cases of borrower non-compliance with significant terms and conditions outlined in the loan contract, any imposed penalties will be categorized as ‘penal charges’. These charges shall not take the form of ‘penal interest’ that is added to the standard interest rate applied to the advances. Moreover, penal charges will not be subjected to interest accumulation, meaning that no additional interest will be computed based on these charges. Nonetheless, it’s important to note that these arrangements will not disrupt the usual protocols for interest compounding in the loan account.
2. Financial institutions (REs) are required to abstain from introducing any supplementary element to the interest rate and must ensure strict adherence to these guidelines in both their literal and intended meanings.
3. REs are mandated to establish a policy endorsed by their respective Boards, specifically addressing penal charges or analogous charges related to loans, regardless of nomenclature.
4. The magnitude of penal charges should be rational and proportionate to the degree of non-compliance with essential terms and conditions stipulated in the loan agreement. This assessment should be impartial and avoid any form of discrimination within specific loan or product categories.
5. For loans granted to “individual borrowers, not intended for business purposes,” the imposed penal charges must not exceed the penal charges applicable to non-individual borrowers in cases of analogous non-compliance with essential terms and conditions.
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6. The extent and rationale behind penal charges must be transparently communicated by REs to customers through the loan agreement, significant terms and conditions, and the Key Fact Statement (KFS) when relevant. Furthermore, this information should be prominently presented on the REs’ website, listed within the “Interest Rates and Service Charges” section.
7. Each time reminders are dispatched to borrowers regarding their failure to adhere to crucial terms and conditions of the loan, the corresponding penal charges will be clearly conveyed. Additionally, any imposition of penal charges and the underlying rationale behind such action will also be communicated to the borrowers.
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