RBI to stop banks from capitalising penal charges on loans, asks stakeholders to submit their comments

The Reserve Bank of India (RBI) has issued draft rules on penal charges related to loan accounts. The regulator stated in a drafted circular on levying penal charges on loan accounts that the penalty should be levied as a charge rather than as a compounding interest rate. RBI released these draft norms on Wednesday and asked the relevant stakeholders to submit their comments by May 15.

RBI said it has been observed that many regulated entities (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.

The quantum of penal charges shall be proportional to the defaults/ non-compliance of material terms and conditions of the loan contract beyond a threshold. This threshold is to be determined by the REs and shall not be discriminatory within a particular loan/product category.

Penal charges and the conditions precedent, therefore, 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.

Whenever reminders for payment of instalments are sent to borrowers, the applicable penal charges shall also be communicated.

The REs shall ensure that there is a clearly laid down Board approved policy on penal charges or similar charges on loans, by whatever name called.

The operationalisation of the ‘penal charges’ in place of ‘penal interest’ will be subject to appropriate review during supervisory examination by the RBI. 

 These instructions shall come into effect from a date to be indicated in the final circular and REs may carry out appropriate revisions in their policy framework and ensure implementation from the effective date.