RBI brings reforms for lending practices, banks can’t use penal charges

The RBI said banks must treat penalties for non-compliance as ‘penal charges’ and it should not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances.

   

The Reserve Bank of India released modified norms, under which lenders would only be able to levy “reasonable” penal charges in case of default in loan repayment, on Friday. This was done because the Reserve Bank was concerned about the practice of banks and Non-Banking Financial Companies (NBFCs) using penal interest as a revenue enhancement tool.

The RBI said banks must treat penalties for non-compliance as ‘penal charges’ and it should not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances.

According to the RBI’s notification on “Fair Lending Practice-Penal Charges in Loan Accounts,” banks and other lending institutions would no longer be permitted to charge penal interest as of January 1, 2024.

“Penalty, if charged, for non-compliance by the borrower of material terms and conditions of the loan contract shall be treated as ‘penal charges’ and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances,” RBI stated in a notification.

The directions were issued after observing that many banks use 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.

“Such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest,” the central bank said.

The RBI’s observations are significant as customers have often complained about a lack of transparency on the part of banks while imposing penal charges on customers.

“The quantum of penal charges shall be reasonable and commensurate with the noncompliance of material terms and conditions of loan contract without being discriminatory within a particular loan or product category,” the RBI circular said.

Reacting to the big breaking, CEO & Founder of FlexPay by Vivifi, Anil Pinapala said, “This marks yet another positive stride taken by the RBI to enhance transparency and uphold equity in lending, prioritizing the interests of borrowers. The recent modifications guarantee that all direct loan-related fees are fully unveiled within the comprehensive Annual Percentage Rate (APR) outlined in the Key Facts Statement (KFS). This ensures that such charges are transparently presented, eliminating any potential concealment within penal charge wordings.”

“Over the past year, the RBI has introduced new directives and updated existing ones about Digital Lending, KYC procedures, Co-Lending (FLDG), and now, Penal charges. These initiatives collectively aim to modernize regulatory frameworks in line with emerging products, technologies, and evolving business/lending models that have extended credit accessibility to previously untapped segments. A consistent theme woven through these actions is a heightened emphasis on standardized disclosures, particularly in relation to rates and charges, rendered in a simplified manner to facilitate borrowers’ comprehension of all lending terms and conditions. This commitment to clarity has now been extended to encompass penal charges as well,” he added.

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