A circular has been released by the Reserve Bank of India (RBI) on August 18, 2023, outlining the procedures for imposing penalties on loan accounts by banks. This step follows the recognition that numerous banks employ an additional penal interest rate, in addition to the established interest rates, when borrowers default or fail to comply with the terms under which credit facilities were granted. These fresh directives are slated to become effective starting January 1, 2024.
Here are some key takeaways concerning the guidelines:
- Banks are permitted to apply penal charges; however, these charges must not manifest as penal interest added onto the interest rate imposed on advances.
- The imposed penal charges should remain reasonable and proportionate, aligning with the nature and scope of the default.
- The accumulation of interest on these penal charges is prohibited, meaning no further interest can be calculated on such fees.
- For loans granted to individual borrowers for non-business purposes, the penal charges should not surpass those applicable to non-individual borrowers.
- Furthermore, as per the RBI guidelines, banks are obligated to transparently reveal the amount and rationale behind any imposed penal charges within the loan agreement. This disclosure should be presented in a straightforward manner and prominently featured within the agreement.
- Additionally, the bank is required to exhibit the critical terms and conditions of the loan, encompassing the penal charges, on its website’s “Interest Rates and Service Charges” section.
The RBI has introduced these guidelines to ensure that banks refrain from exploiting borrowers through unfair penalties. Additionally, the guidelines establish an equitable landscape for borrowers, irrespective of whether they are individuals or businesses.
How to check for “penal charges” in a loan agreement?
If you are contemplating obtaining a loan, it is crucial to meticulously peruse the loan agreement and to seek clarification from the bank regarding any queries you may have about the terms and conditions. Additionally, it's advisable to review the bank's website to ascertain whether the penal charges for the loan have been disclosed.
Here are a few pointers to aid in comprehending the penal charges outlined in a loan agreement:
- Navigate to the section dedicated to “Penal Charges” or “Default Charges”.
- Thoroughly comprehend the definition of each category of charge.
- Gain a clear grasp of the scenarios in which these charges may be imposed.
- Conduct a calculation of the potential cumulative sum of charges for which you might be held responsible.
Effective date of the change
For newly acquired or renewed loans originating from January 01, 2024, banks are obliged to adopt the updated guidelines. In the case of preexisting loans, banks must transition to the new penal charges framework either upon the subsequent review or renewal date or within six months of the circular's effective date, whichever comes first.
This grace period granted by the RBI offers banks the opportunity to smoothly adapt to the new regulations. To adhere to the revised guidelines, banks will need to modify their systems and procedures. Additionally, they are required to communicate these alterations to their customers.
The introduction of the new penal charges system is a positive development for borrowers. It serves to shield them from inequitable practices and guarantees equitable treatment by financial institutions. If you possess an existing loan, it is crucial to liaise with your bank to ascertain when the transition to the updated penal charges system will be enacted.
According to the RBI, the primary purpose of imposing penal interest or charges is to instil credit discipline, and these charges should not be utilized as a means to augment revenue beyond the agreed-upon interest rate. Nonetheless, regulatory evaluations have revealed contrasting approaches among banks concerning the imposition of penal interest/charges, resulting in customer complaints and conflicts.
The scope of the RBI circular extends to encompass all commercial banks, small finance banks (excluding payment banks), NBFCs, which include housing finance companies, and additional financial entities like SIDBI and EXIM banks.
