Mumbai, August 18th: In response to growing concerns regarding the practice of banks and Non-Banking Financial Companies (NBFCs) using penal interest as a means to boost their revenue, the Reserve Bank of India (RBI) announced revised guidelines on Friday. According to these updated norms, lenders will now be permitted to impose only “reasonable” penal charges in cases of loan repayment defaults.
Starting from January 1, 2024, banks and other lending institutions will be prohibited from imposing penal interest, as stated in the RBI’s notification titled ‘Fair Lending Practice-Penal Charges in Loan Accounts’.
The RBI clarified that penalties, if imposed, due to borrowers not adhering to essential terms and conditions of the loan contract will be categorized as ‘penal charges’. These charges will no longer be integrated into the interest rate applied to the advances, a practice known as ‘penal interest’.
The notification further emphasized that the magnitude of these penal charges must be fair and proportionate to the extent of noncompliance with the material terms and conditions of the loan contract. Importantly, this should be applied uniformly across various loan/product categories without any form of discrimination.
Additionally, the RBI specified that penal charges cannot accumulate further interest, preventing the compounding of charges over time.
It’s important to note that these instructions won’t be applicable to credit cards, external commercial borrowings, trade credits, and structured obligations that fall under product-specific regulations, as outlined by the RBI.
Addressing the rationale behind this move, the RBI highlighted that certain entities under its regulatory purview have been implementing varying rates of penal interest, alongside regular interest rates, for borrower defaults or non-compliance. The central bank clarified that the primary purpose of imposing penal interest/charges is to foster a sense of credit discipline. These charges were never intended to serve as an additional tool for revenue generation, beyond the initially agreed-upon interest rate.
In light of observed discrepancies in practices among regulated entities concerning the imposition of penal interest/charges, the RBI issued these modified norms to address customer grievances and disputes through a more standardized approach.
