RBI issues new guidelines for banks, NBFCs to regulate penal interest on loans

The Reserve Bank of India (RBI) on Friday issued a fresh set of guidelines for banks and other regulated entities (REs) on the imposition of penal charges on loan borrowers.  

The guidelines have been issued after it was reported that many banks use penal rate 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 guidelines will be effective from January 1, 2024.  

These guidelines were first announced by RBI governor Shaktikanta Das at the April monetary policy. 

The circular noted: 

* Penalty, if charged, for non-compliance with terms and conditions of a 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 interest in the loan account. 

* The RBI has asked the banks not to introduce any additional component to the rate of interest and ensure compliance with these guidelines in both letter and spirit. 

* The banks, the RBI said, shall formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called. 

* The amount of the penal charge shall be reasonable and commensurate with non-compliance with the terms and conditions of the loan contract without being discriminatory within a particular loan or product category, the central bank said. 

* The guidelines also mandate that the quantum and rationale behind penal charges must be clearly disclosed to customers in the loan agreement, the Key Fact Statement (KFS), and prominently displayed on the REs' websites. 

*Additionally, REs are required to communicate applicable penal charges to borrowers whenever reminders for non-compliance are sent.  

* Any instance of levying penal charges and the reasons for such actions must also be communicated to borrowers. 

* In a bid to safeguard individual borrowers, the RBI specified that penal charges for loans sanctioned to non-business individuals should not exceed the charges applicable to non-individual borrowers for similar non-compliance. 

* For existing loans, REs must transition to the new penal charges regime at the next review or renewal date or within six months from the effective date of the circular, whichever comes earlier. 
 

In April, Governor Das said that these rules would be applicable to all entities regulated by the RBI, including all commercial banks, co-operative banks, NBFCs (including housing finance companies), and All India Financial Institutions like EXIM Bank, NABARD, NHB, SIDBI and NaBFID. 

The central bank stated that these guidelines will not extend to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations, as these products are covered under product-specific directions. 

 

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In July, Union Finance Minister Nirmala Sitharaman during the Monsoon Session in the parliament said the government has instructed both public and private banks that harsh steps should not be taken when it comes to the process of loan repayment. 

"I have heard complaints about how mercilessly loan repayments have been followed up by some banks. The government has instructed all banks, both public and private, that harsh steps should not be taken when it comes to the process of loan repayment, and they should approach the matter with humanity and sensitivity in mind," she told Lok Sabha on July 24. 

 

 

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In 2008, the RBI had warned banks that it might consider imposing a ban on a bank from engaging recovery agents if it receives complaints about the agents. Further, the banks were asked to periodically review their recovery mechanism and give their feedback/ suggestions for improvement in the guidelines. 

 The central bank has regularly issued circulars aimed at curbing harassment by recovery agents hired by banks and Non-Banking Financial Companies. 

In March 2023, the RBI fined RBL Bank Ltd of Rs 2.27 crore for not complying with certain directives on loan recovery agents. The RBI noticed "deficiencies in regulatory compliance" after it examined complaints received against the Mumbai-based lender's recovery agents during the financial years 2018-19 to 2021-22, the central bank had said in a statement. 

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