The Reserve Bank of India (“RBI”) has issued a notification on “Fair Lending Practice – Penal Charges in Loan Accounts” with the following instructions on a review of the practices followed by Regulated Entities (“REs”) for charging penal interest/charges on loans:
(i) Penalty, if charged, for non-compliance of material terms and conditions of loan contract by the borrower must be treated as ‘penal charges’ and should not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances. REs should ensure that there is 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.
(ii) The REs should ensure that they do not introduce any additional component to the rate of interest and ensure compliance to these guidelines in both letter and spirit.
(iii) The REs have to formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called.
(iv) The quantum of penal charges must 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.
(v) 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.
(vi) The quantum and reason for penal charges shall be clearly disclosed by REs to the customers in the loan agreement and most important terms & conditions / Key Fact Statement (KFS) as applicable, in addition to being displayed on REs website under Interest rates and Service Charges.
(vii) 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.
Please note, these instructions will gain effect from 1st January, 2024. Regulated Entities may 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 shall be ensured on next review or renewal date or six months from the effective date of this circular, whichever is earlier.
Further, these instructions will not apply to Credit Cards, External Commercial Borrowings, Trade Credits and Structured Obligations which are covered under product specific directions.
Source: Reserve Bank of India
