Recovery of Penal interest for delay/default in servicing of the loan shall be stopped: RBI

The Statement on Developmental and Regulatory Policies dated February 8, 2023 sets out various developmental and regulatory policy measures relating to (i) Financial Markets; (ii) Regulation; (iii) Payment and Settlement Systems and (iv) Currency Management.

In its statement today, India’s central bank announced that it will issue draft guidelines for transparency in the penal charges or penal interest charged on loans.

Pointing out that the Banks and NBFCs follow divergent practices on levying penal charges and in some cases excessive charges,  RBI  said draft guidelines will be issued on the subject to enhance transparency, reasonableness and protection of the consumers.

Currently, Regulated Entities (REs) have the operational autonomy to formulate Board approved policy for levy of penal interest on advances which shall be fair and transparent.  However, each bank has its own policy to levy the penal charges which were excessive in certain cases, leading to customer grievances and disputes.

“The intent of penal interest was essentially to inculcate a sense of credit discipline among borrowers through negative incentives but such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest” said RBI.

Given the forgoing, RBI decided that any penalty for delay/default in servicing of the loan or any other non-compliance of material terms and conditions of loan contract by the borrower shall be in the form of ‘penal charges’ in a reasonable and transparent manner and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest being charged on the advances. Further, there shall be no capitalisation of penal charges (i.e., the same shall be recovered separately and shall not be added to the principal outstanding).

However, banks and financial institutions (regulated entities) shall be free to alter the credit risk premium under extant guidelines on interest rate, in case of any deterioration in credit risk profile of the borrower, it said., REs shall be free to alter the credit risk premium under extant guidelines on interest rate.

‘Draft guidelines to the above effect shall be placed on RBI website shortly, for comments from stakeholders’ the statement said.