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Lenders can impose penalty on defaults only as 'penal charges': RBI

Regulated entities are barred from imposing such charges in the 'penal interest' that is added to the rate of interest charged on the advances

Mumbai: A security personal outside Reserve Bank of India (RBI) headquarters, in Mumbai, Wednesday, June 8, 2022. (PTI Photo

The regulator said it has been observed that many REs use penal rates of interest, over and above the applicable interest rates, in case of defaults/non-compliance by the borrower with the terms on which credit facilities were sanctioned.

Abhijit Lele Mumbai

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The Reserve Bank of India (RBI) said on Friday that the penalty imposed by regulated entities (REs) on customers for defaults and breaching conditions of loan contracts is to be treated as ‘penal charges’. REs are barred from imposing such charges in the ‘penal interest’ that is added to the rate of interest charged on the advances.

“There shall be no capitalisation of penal charges aka no further interest computed on such charges. However, this will not affect the normal procedures for compounding of interest in the loan account,” RBI said in a communication to REs.

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These instructions will come into effect from January 1, 2024. REs may carry out appropriate revisions in their policy framework and ensure implementation of the instructions in respect of all the fresh loans availed/ renewed from the effective date. For the existing loans, the switchover to new penal charges regime shall be ensured on next review or renewal date or six months from the effective date of this circular, whichever is earlier.

The regulator said it has been observed that many REs use penal rates of interest, over and above the applicable interest rates, in case of defaults/non-compliance by the borrower with the terms on which credit facilities were sanctioned. These instructions shall, however, not apply to Credit Cards, External Commercial Borrowings, Trade Credits and Structured Obligations which are covered under product specific directions.

The intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline and such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest. However, supervisory reviews have shown divergent practices amongst the REs with regard to levy of penal interest/charges leading to customer grievances and disputes.

RBI said lenders should not introduce any additional component to the rate of interest and ensure compliance with these guidelines in both letter and spirit. They have to formulate a board approved policy on penal charges or similar charges on loans, by whatever name called.

The quantum of penal charges should be reasonable and commensurate with the non-compliance of material terms and conditions of loan contract without being discriminatory within a particular loan / product category.

The penal charges for loans sanctioned to ‘individual borrowers, for purposes other than business’, shall not be higher than the penal charges applicable to non-individual borrowers for similar non-compliance of material terms and conditions.

The quantum and reason for penal charges shall be clearly disclosed to the customers in the loan agreement and most important terms & conditions/Key Fact Statement as applicable. This would be in addition to being displayed on REs website under Interest rates and Service Charges, it added.

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First Published: Aug 18 2023 | 10:22 AM IST

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