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Reserve Bank of India (RBI) has issued fresh guidelines to the Regulated Entities (REs) such as commercial and other banks, Non-Banking Finance Companies (NBFCs) and other lenders to ensure reasonableness and transparency in disclosure of penal interest. 

This follows findings that many REs are using penal rates 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 intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline and such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest,” the RBI said in a circular. 

“However, supervisory reviews have indicated divergent practices amongst the REs with regard to levy of penal interest/charges leading to customer grievances and disputes,” it added.

According to the new directive, penalty if charged for non-compliance of material terms and conditions of loan contract by the borrower would 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 of interest in the loan account,” the circular said. 

The REs have been asked not introduce any additional component to the rate of interest and ensure compliance to these guidelines in letter and in spirit.

Board approved policy

The REs will formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called.

And the quantum of penal charges shall be reasonable and commensurate with the non-compliance of material terms and conditions of loan contract without being discriminatory within a particular loan / product category.

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 non-individual borrowers for similar non-compliance of material terms and conditions.

Now the RBI wants the REs to clearly disclose the quantum and reason for penal charges to the customers in the loan agreement and most important terms & conditions / key fact statement as applicable, in addition to being displayed on REs website under Interest Rates and Service Charges.

“Whenever reminders for non-compliance of material terms and conditions of loan are sent to borrowers, the applicable penal charges shall be communicated. Further, any instance of levy of penal charges and the reason therefor shall also be communicated,” the RBI circular said. 

These instructions will come into effect from January 1, 2024. 

And the REs have been asked to carry out appropriate revisions in their policy framework and ensure implementation of the instructions in respect of all the fresh loans availed/ renewed from the effective date. 

In the case of existing loans, the switchover to new penal charges regime will be ensured on next review or renewal date or six months from the effective date of this circular, whichever is earlier, the circular said.

These instructions will, however, not apply to Credit Cards, External Commercial Borrowings, Trade Credits and Structured Obligations which are covered under product specific directions, the RBI has clarified.