RBI issues draft guidelines for penalty charges on loan accounts

RBI issues draft guidelines for penalty charges on loan accounts

States that the lending institutions have the autonomy to formulate board-approved policy for levying fines

The Reserve Bank of India (RBI) has issued various guidelines to Regulated Entities (REs) to ensure reasonable and transparency in the disclosure of penalty interest.

The RBI, however, observed that many REs used penal rates of interest, over and above the applicable interest rates in case of defaults or non-compliance by the borrower with the terms on which credit facilities were sanctioned.

It stated that the intent of levying penal interest/charges was essentially to inculcate a sense of credit discipline among borrowers through negative incentives and ensure fair compensation to the lender. The penal charges were not to be used as a revenue enhancement tool over and above the contracted rate of interest.

Meanwhile, the supervisory reviews have indicated divergent practices amongst the REs on the levy of penal interest/charges leading to customer grievances and disputes.

RBI further stated that the determination of interest rates on credit facilities, including conditions for reset of interest rates, would be strictly governed by the relevant regulatory instructions issued. Also, REs shall not introduce any additional component to the rate of interest.

It added that if charged, the penalty would be treated as penal ‘charges’ and not as a form of penal ‘interest’ that is added to the rate of interest charged on the advances.

The regulatory body said, “It needs to be recognized that the rate of interest on a loan includes appropriate credit risk premium reflecting the credit risk profile of the borrower. If the credit risk profile of the borrower undergoes change, REs will be free to alter credit risk premium as per the contracted terms and conditions, in terms of extant instructions."

The central bank said that the penal charges in case of loans sanctioned to individual borrowers (for purposes other than business), would not be higher than the penal charges applicable to non-individual borrowers.