RBI Bans Pre-Payment Charges on Floating Rate Loans for Individual Borrowers

Article:
The Reserve Bank of India (RBI) has issued a directive prohibiting banks and other regulated entities from levying pre-payment penalties on floating rate loans availed by individual borrowers for non-business purposes. The new framework, titled Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025, will come into effect from January 1, 2026. This move is aimed at enhancing transparency and providing greater flexibility to borrowers.

The Directions will apply to all commercial banks (excluding payment banks), co-operative banks, Non-Banking Financial Companies (NBFCs), and All India Financial Institutions. The prohibition on pre-payment charges will remain valid irrespective of whether the loan is fully or partially repaid, the source of repayment funds, or the presence of co-obligants. Loans with dual or special rates will also fall under the purview of this regulation, provided they operate on a floating rate at the time of repayment. No minimum lock-in period is mandated for availing this benefit.

For loans not covered under the exemption, regulated entities (REs) are required to disclose any applicable pre-payment charges clearly in the sanction letter, loan agreement, and the Key Facts Statement (KFS). This measure aims to curb the prevalent practice among some lenders of including restrictive clauses that hinder borrowers from switching to more favourable loan terms, thereby strengthening consumer protection.

Regulatory Background and Key Provisions:

RBI’s supervisory assessments have highlighted inconsistent practices among regulated entities regarding the imposition of pre-payment charges, particularly on loans extended to Micro and Small Enterprises (MSEs), leading to customer complaints and disputes. Additionally, certain lenders have been found to insert clauses in loan agreements that disincentivize borrowers from transferring their loan accounts to other institutions offering better terms.

Based on a review of these supervisory findings and public feedback received on the draft circular, the Reserve Bank has invoked its powers under Sections 21, 35A, and 56 of the Banking Regulation Act, 1949; Sections 45JA, 45L, and 45M of the Reserve Bank of India Act, 1934; and Section 30A of the National Housing Bank Act, 1987 to issue the following directives:

Applicability of Directions:

1. Floating Rate Loans for Non-Business Purposes
   1. No pre-payment charges shall be levied by any RE on loans granted to individuals (with or without co-obligants) for purposes other than business.
2. Floating Rate Loans for Business Purposes
   1. For loans to individuals and MSEs:
      1. No pre-payment charges shall be imposed by commercial banks (excluding Small Finance Banks, Regional Rural Banks, and Local Area Banks), Tier 4 Primary (Urban) Co-operative Banks, NBFCs in the Upper Layer (NBFC-UL), and All India Financial Institutions.
      1. No pre-payment charges shall be imposed by Small Finance Banks, Regional Rural Banks, Tier 3 Primary (Urban) Co-operative Banks, State Co-operative Banks, Central Co-operative Banks, and NBFCs in the Middle Layer (NBFC-ML) on loans with a sanctioned amount or limit up to ₹50 lakh.
3. General Provisions
   1. The above stipulations will apply irrespective of the source of pre-payment and regardless of whether the loan is prepaid fully or in part.
   1. There shall be no minimum lock-in period for availing the benefit.
   1. In the case of dual or special rate loans, the determining factor for applicability will be whether the loan is on a floating rate at the time of pre-payment.
4. Special Cases
   1. For term loans, if pre-payment charges are levied, they must be based solely on the amount being prepaid.
   1. For cash credit/overdraft facilities, pre-payment charges (in case of early closure) shall not exceed the amount sanctioned.
   1. No pre-payment charges shall apply if the borrower notifies the RE of their intent not to renew the facility within the timeframe specified in the loan agreement and the account is closed on the due date.
5. Additional Protections for Borrowers
   1. No charges may be levied if the pre-payment is initiated by the RE.
   1. REs are prohibited from retrospectively applying any charges or fees that had previously been waived.
   1. All applicable charges must be clearly stated in the sanction letter, loan agreement, and, where applicable, the Key Facts Statement (KFS) as per the RBI’s circular dated April 15, 2024.
   1. No pre-payment charges may be levied unless disclosed in accordance with the above provisions.

This comprehensive directive is expected to improve transparency, reduce customer grievances, and encourage greater competition among lenders by enabling borrowers to refinance or switch their loans without penalty.