“Stay informed about the recent RBI guidelines on fair lending practices and changes in penal charges for loan accounts. Learn about the treatment of penal charges, additional interest components, and board-approved policies. Ensure transparency in disclosure and communication of charges. Effective from January 1, 2024, these guidelines apply to various financial institutions. For more details, refer to the RBI circular dated August 18, 2023.”
We are writing to inform you about the recent guidelines issued by the Reserve Bank of India (RBI) vide RBI/2023-24/53 DoR.MCS.REC.28/01.01.001/2023-24 dated August 18, 2023, regarding fair lending practices and the imposition of penal charges on loan accounts. These guidelines, effective from January 1, 2024, are applicable to all Commercial Banks (including Small Finance Banks, Local Area Banks, and Regional Rural Banks), Primary (Urban) Co-operative Banks, NBFCs (including HFCs), and All India Financial Institutions (EXIM Bank, NABARD, NHB, SIDBI, and NaBFID).
The RBI recognizes the significance of ensuring transparency and reasonableness in the disclosure of penal charges. The guidelines aim to promote credit discipline without penal charges being utilized as a means of revenue enhancement. To address varying practices among financial institutions and prevent customer grievances, the following instructions have been issued for your consideration and implementation:
1. Treatment of Penal Charges: Penal charges for non-compliance with material terms and conditions of the loan contract by the borrower shall be treated as ‘penal charges’ and not as ‘penal interest’ added to the interest rate on advances. These charges shall not be capitalized, meaning no additional interest will be calculated on them. Normal procedures for interest compounding in the loan account remain unaffected.
2. Additional Interest Component: Financial institutions are prohibited from introducing any extra component to the interest rate and are required to adhere to these guidelines both in letter and spirit.
3. Board-Approved Policy: Financial institutions are to formulate a Board-approved policy on penal charges or similar charges on loans, regardless of nomenclature.
4. Reasonable Quantum: The quantum of penal charges should be reasonable and proportional to the non-compliance of material terms and conditions of the loan contract. These charges should not be discriminatory within a particular loan/product category.
5. Individual Borrowers: For loans sanctioned to ‘individual borrowers, for purposes other than business,’ penal charges shall not exceed those applicable to non-individual borrowers for similar non-compliance.
6. Disclosure and Communication: The quantum and rationale behind penal charges must be transparently communicated to customers in the loan agreement, most important terms & conditions, and Key Fact Statement (KFS), if applicable. This information should also be displayed on the financial institution’s website under ‘Interest Rates and Service Charges.’
7. Communication of Charges: Applicable penal charges should be communicated to borrowers when reminders for non-compliance are sent. Instances of levying penal charges and the reasons for them should also be conveyed.
8. Effective Date: These instructions will be effective from January 1, 2024. Financial institutions should revise their policy framework as necessary and implement these guidelines for all fresh loans availed or renewed from this date. For existing loans, the transition to the new penal charges regime should be ensured on the next review or renewal date, or within six months from the effective date of this circular, whichever is earlier.
These instructions have been issued under relevant sections of the Banking Regulation Act, 1949, the Reserve Bank of India Act, 1934, and the National Housing Bank Act, 1987. Please refer to the Annex in RBI/2023-24/53 DoR.MCS.REC.28/01.01.001/2023-24 dated August 18, 2023 for a list of amendments to the Master Directions / Master Circulars that pertain to these guidelines.
Kindly note that these guidelines do not apply to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations, which are covered under product-specific directions.
We encourage you to review your internal policies and procedures to ensure timely compliance with these guidelines.
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