The Reserve Bank of India (RBI) on Friday issued new guidelines for levying penal interest rates on loan accounts. Under the new guidelines, the penalty for non-compliance of loan terms by the borrower will be treated as “penal fee” and not as “penal interest”, which is added to the rate of interest charged on advances.

The guidelines titled “Fair Lending Practices – Penal Charges in Loan Accounts” also stated that there will be no capitalization of penal charges. This means that no further interest will be calculated on such charges.

“However, this will not affect the normal processes of compounding of interest in the loan account,” the central bank said in an announcement.

Penal charges are levied on the loan when a customer fails to pay his due installment on time.

For example, assume the borrower’s installment payment for the month of August is Rs 1,000 at 10 per cent interest rate. In case of default in timely installment payment, they will have to pay an additional or penal interest of 24 per cent per annum. Its amount will be 2 percent per month and it will be over and above the 10 percent already due.

Now, the guidelines state that the “penal interest” of 2 per cent will be replaced by a “penal fee” with no additional component in the interest rate.

The RBI had released a draft for penal charges in April this year.

The new guidelines also state that penal charges in case of loans sanctioned to “individual borrowers for purposes other than business” shall not exceed the penal charges applicable to non-individual borrowers for similar non-compliance with material terms and conditions will be.

It added that whenever reminders are sent to borrowers for non-compliance of important terms and conditions of the loan, applicable penal charges will be informed. In addition, any instance and reason for imposition of penal charges shall also be reported.

Further, regulated entities (REs) will be permitted to constitute a board for approving penal charges or similar charges, by whatever name called, on loans.

“The quantum of penal fee shall be reasonable and commensurate with non-observance of material terms and conditions of the loan agreement without discriminating within any particular loan/product category,” RBI said.

“The quantum and reason for the penal charge shall be clearly communicated by RES to the customers in the loan agreement and most important terms and conditions/Key Fact Statement (KFS), besides being displayed on the RES website under interest rates and service charges. ,” it added.

These instructions will be applicable from 1 January 2024.

RES have been asked to make suitable amendments in their policy framework and ensure implementation of the instructions for all new loans availed/renewed from the effective date.

“In case of existing loans, the transition to the new penalty fee regime shall be ensured by the next review or renewal date or six months from the effective date of these directions, whichever is earlier,” RBI said.

However, these will not apply to credit cards, external commercial borrowings, trade credit and structured obligations, which are covered under product-specific instructions.

Why have these guidelines been issued?

According to RBI, these guidelines have been issued to “instill a sense of credit discipline”. However, it cautioned that “such fees are not used as a revenue enhancement tool in excess of the contracted rate of interest.”

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