RBI's prepayment penalty ban poses bigger hit for NBFCs, say experts

NBFCs have around 5-25 per cent of their AUM under floating rate micro, small, and medium enterprises (MSMEs) loans which will be impacted as majority of them charge 2-5 per cent prepayment penalties

The fee income of banks and non-banking finance companies will come under pressure due to Reserve Bank of India’s (RBI’s) decision to bar prepayment penalty on fresh loans for micro and small enterprises, effective 1 January, 2026. However, the impact on NBFCs will be more as compared to commercial banks, experts said.

 

NBFCs have around 5-25 per cent of their asset under management (AUM) under floating rate micro, small, and medium enterprises (MSMEs) loans which will be impacted as majority of them charge 2-5 per cent prepayment penalties.

 

At the same time, fee income of banks is less than 1 per cent of their total income, hence the impact of these changes will be minimal on banks, industry experts said.

 

“It will have a negative impact on the non-operating income component of the regulated entities, which are focused on MSMEs and have longer tenured floating rate loan products,” Sachin Sachdeva, vice president, Financial Sector Ratings, ICRA Limited stated.

 

“Nevertheless, with these directions, the central bank has tried to harmonise the practice across lenders, given the divergent practices amongst banks and NBFCs, and at the same time it increases the affordability of financing for micro and small enterprises,” he added.

 

An exception was made on the prepayment penalty norms for small finance banks, urban co-operatives and regional rural banks, as these entities are barred from such charges on loans up to ₹50 lakh.

 

The directions are applicable irrespective of the source of funds used for prepayment of loans, either in part or in full, and without any minimum lock-in period.

 

NBFCs such as PNB Housing Finance, Aditya Birla Capita, and Piramal Enterprises are expected to be impacted the most as they account for the majority of floating rate MSME loans and loan against property (including MSME loans). 

 

According to the IIFL Securities report, PNB Housing Finance accounts for 27 per cent of floating rate MSME loan followed by Aditya Birla Capital, which has 26 per cent of these loans, and Piramal Enterprises accounts for 22 per cent.

 

The report also said that it is expected that there would be material increase in competitive intensity in loan against property and floating rate MSME loans, reducing their profitability structurally as exit barriers are removed.

 

“Banks and large NBFCs with lower cost of funds will be able to partially offset this by increasing the share of more granular and higher yielding customers within these segments,” the report said.

 

“Currently, we levy 4 per cent fee/penalty on full early payment and 2 percent for part pre-payment. With these changes, we will have to bear a loss of 2-4 percent,” said an official with an NBFC.

 

Meanwhile, impact on banks will be limited as the fee income is near 1 per cent of total income of a bank, bankers said.

 

“As a bank, pre-payment fees account for just 0.5-0.6 per cent of total income hence the impact will be minimal. Earlier, we could enter into a lock-in period for pre-payments, this we have to forego,” said a senior banking official with a public sector bank.

 

From a customer’s perspective, the circular on prepayment charges on loans is a positive move by the regulator to ensure that the customers are protected from levy prepayment charges on the closure of loans, said Sanket Agrawal, chief strategy officer, SBFC Finance.

 

“However, it is important to note that the circular applies to floating rate loans that are sanctioned on or after 1st January, 2026 which means that the loan book as on today does not get impacted. Also, a borrower does not close a higher tenure loan in the first few years and therefore the impact of the circular on prepayment fee income of finance companies will be at a lag. This circular helps the borrowers to get credit at a fair price in its long tenure repayment cycle.”