If a customer contests a penal charge due to a bank error and the bank confirms the mistake, the charged amount is reversed back to the borrower's account
The Reserve Bank of India (RBI) issued a directive to prevent extra charges on loan accounts on August 18, 2023, which came into effect on April 1, 2024 (for existing loans, the switchover shall be ensured on the next review/ renewal date falling on or after April 1, 2024, but not later than June 30, 2024).
“As per the new RBI directive, in case of delayed payments of personal loans, the penalty would be charged as penal charges (and not as penal interest that was earlier charged based on the overdue amount and the duration of the delay),” says Gulzar Didwania, Partner, Deloitte India.
For instance, if you miss a payment due date on your loan, the lender can charge you a penal charge based on your loan agreement. Say the lender charges you Rs 2000.
“However, there are two things to keep in mind. There can be no capitalization of this penal charge, i.e., the lender cannot charge a compound interest if it remains unpaid. Second, the lender cannot introduce any additional component to the interest rate. So, your penal charge cannot be added to your outstanding and compounded month on month. That will remain separate,” says Adhil Shetty, CEO, BankBazaar.com, a fintech company.
However, bear in mind that in the case of long-term floating loans like home loans, the lender can change the spread on the loan to compensate for the risk in case the credit score goes up or down significantly.
Here, it is important to note the rule on the reversal of charges.
“The rule on reversal of charges accrued on loans typically applies when there is an error or dispute resolved in favour of the borrower. For instance, if a customer contests a penal charge due to a bank error and the bank confirms the mistake, the charged amount is reversed back to the borrower's account,” says Rajiv Das, CEO, I-Loans, LoanTap, a digital lending platform.
Also, in the case of non-performing assets (NPAs), any income that hasn’t been collected should stop being recorded as earnings by the lender. “This also includes any uncollected penal charges, which will need to be reversed to avoid being recognized as income. However, these charges still count as part of the total debt the borrower owes to the lender unless they are officially forgiven according to the bank’s policy approved by its board,” says Shetty.
In terms of circular number 178/10/2022-GST dated 3 August 2022, goods and services Tax (GST) is applicable on charges collected for pre-payment, late payment of loan, etc. “However, GST is not applicable on any charges collected on account of dishonour of cheque since the same is considered as a deterrent measure, discouraging such an act or situation.
“Hence, in light of the said circular, the GST authorities may take a view that the penal charges for late payment, etc. are consideration for the service provided by banks in the form of toleration of material breach of terms and conditions contemplated in the contract between bank/Financial institution and the customer. Further, such GST would be borne by the customer and is added to the penal charges,” says Didwania.
For example, if the penal charge is Rs 200 and the applicable GST rate is 18 per cent, the total amount payable by the customer would be Rs 236 (Rs 200 + Rs 36 GST).
“However, the said clarification required reconsideration of the Central Board of Indirect Taxes and Customs (CBIC) in light of the new directive issued by the RBI since the directive states that penal charges are only to enforce credit discipline,” he adds.