The Reserve Bank of India (RBI) has extended the deadline for implementing charges levied on loan accounts. As per the circular issued by the RBI on December 29, 2023, the deadline has been extended by three months and new rules will be introduced from April 1, 2024, but not later than June 30, 2024.
In August 2023, the RBI issued a circular on how banks can levy penalties on loan accounts. The new guidelines were supposed to come into effect from January 1, 2024. However, considering that certain clarifications were needed in this regard and additional time was required by banks and NBFCs the implementation date is extended.
As per the circular issued on December 29, 2023, “In terms of paragraph 3 (viii) of the circular, the instructions were to come into effect from January 1, 2024. However, considering that certain clarifications and additional time has been sought by some regulated entities (REs) to reconfigure their internal systems and operationalize the circular, it has been decided to extend the timeline for implementation of the instructions by three months. Accordingly, REs shall ensure that the instructions are implemented in respect of all the fresh loans availed from April 1, 2024 onwards. In the case of existing loans, the switchover to new penal charges regime shall be ensured on the next review/ renewal date falling on or after April 1, 2024, but not later than June 30, 2024.”
Also Read: Banks, NBFCs cannot compound penal charges
Hence, for all the new loans issued on or after April 1, 2024, the penal charges that will be levied in case of default will be based on the revised guidelines. However, for existing loans the revised penal charges must be implemented by June 30, 2024.
What are the revised guidelines issued by RBI on levying penal charges?
RBI issued the new guidelines after it was observed that many banks use penal rate 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.
The circular issued in August 2023 clarified that penalties, if imposed due to non-compliance with the terms and conditions of a loan contract by the borrower, would be considered as ‘penal charges’ and not as ‘penal interest’ added to the interest rate on the advances. Consequently, there would be no capitalization of penal charges, meaning no additional interest would be calculated on such charges. However, this clarification would not impact the standard procedures for compounding interest in the loan account.
The circular emphasized that the amount of penal charges should be reasonable and proportionate to the degree of non-compliance with the terms and conditions of the loan contract, without any discriminatory practices within a specific loan or product category. For loans granted to ‘individual borrowers for purposes other than business,’ such as home loans and personal loans, the penal charges should not exceed those applicable to non-individual borrowers for similar non-compliance.
Banks are required to disclose the amount and rationale for penal charges in the loan agreement, and crucial terms and conditions, including a Key Fact Statement (KFS) where applicable, should be prominently displayed on the banks’ websites under the Interest Rates and Service Charges section.
In cases where reminders for non-compliance are sent to borrowers, the relevant penal charges must be communicated. Additionally, any instance of imposing penal charges and the reasons for such action should be transparently communicated to the borrowers.
What RBI said while issuing revised guidelines?
As per the RBI, the primary purpose behind imposing penal interest or charges is to foster credit discipline, emphasizing that these charges should not serve as a means of revenue enhancement beyond the contracted interest rate. Nevertheless, supervisory reviews have revealed varied practices among banks in the imposition of penal interest/charges, resulting in customer grievances and disputes.
In response, the RBI has directed banks to refrain from introducing any supplementary component to the interest rate and to diligently adhere to these guidelines in both their literal interpretation and intended spirit. Banks are required to develop a board-approved policy on penal charges or similar fees associated with loans, irrespective of the nomenclature used.