The Reserve Bank of India (RBI) on January 16, 2024 announced the implementation of revised fair lending practices from April 1, 2024, aimed at prohibiting banks and non-banking financial companies (NBFCs) from using penal charges on loan defaults as a revenue generation tool.
To promote fairness, transparency, and accountability, the RBI had in August 2023 issued comprehensive fair lending guidelines applicable to scheduled commercial banks, small finance banks, local area banks, regional rural banks (RRBs), primary (urban) co-operative banks, NBFCs and all India financial institutions.
Fair Lending Practice Rules
The guidelines state that any penalty for non-compliance with material terms and conditions of a loan contract shall be treated as ‘penal charges’ rather than ‘penal interest’.
“Any penalty levied due to delay/default in servicing a loan, or any other non-compliance of material terms and conditions of a loan contract, by a borrower, shall be levied in the form of ‘penal charges’, in a reasonable and transparent manner, and not in the form of ‘penal interest’ that is added to the rate of interest being charged on the advances made,” RBI said.
Further, these charges should be reasonable and commensurate with the level of non-compliance, which should be clearly disclosed in loan agreements or terms and conditions. Also financial institutions must prominently display penal charges on their websites under the section ‘interest rates and service charges’.
Additionally, the guidelines mandate that a Board-approved policy on penal charges must be formulated, outlining the rationale and criteria for determining charges, and their applicability across different loan/product categories. Further, penal charges for individual borrowers should not exceed those for non-individual borrowers facing same non-compliance.
RBI FAQs Provide More Clarification
The RBI clarified that the instructions will apply to existing loans from April 1, 2024. The switchover to the new penal charges regime shall be ensured on the next review or renewal date falling on or after April 1, 2024, but not later than June 30, 2024, RBI said.
The frequently asked questions (FAQs) also clarified that default in repayment also came under the purview of this guidelines.
“Such penal charges shall be reasonable and levied by the lenders only on the amount under default in a non-discriminatory manner as per their Board-approved policy. Further, it must be ensured that there is no capitalisation of the penal charges and no further interest computed on such charges,” it said.
It further said that while no upper limit for penal charges has been outlined, banks are urged to ensure charges are reasonable.
The guidelines also extend to securitisation and co-lending portfolios but exempt rupee or foreign currency export credit and other foreign currency loans, it added.
