Fair Lending Practice-Penal Charges in Loan Accounts

Table of Contents☰

What’s in today’s article?

Why in News?
About the Modified Norms
Other Highlights of the Modified Norms
Impact on Consumers

Why in News?

Concerned over the practice of banks and Non-Banking Financial Companies (NBFCs) using penal interest as a revenue enhancement tool, the Reserve Bank of India (RBI) came out with modified norms.

About the Modified Norms:

The norms were released after the RBI found that many regulated entities (REs) – lending institutions regulated by the central bank – were levying penal rates of interest, over and above the applicable interest rates.
According to the RBI notification on ‘Fair Lending Practice-Penal Charges in Loan Accounts’, the banks and other lending institutions will not be allowed to levy penal interest (wef Jan 1, 2024).
- Penal interest is added to the rate of interest charged on the advances.
They would levy only penal charges in case of defaults or non-compliance by the borrower with the terms on which credit facilities were sanctioned.
- A penal charge is an additional charge a lender levies on a borrower in case of delay in payment of equated monthly installments (EMI) or default or non-compliance of payment contracts.
- The quantum of penal charges should be “reasonable” and “commensurate with the non-compliance of loan contract” without being discriminatory within a particular loan/ product category.
- There shall be no capitalisation of penal charges i.e., no further interest computed on such charges.
- However, this will not affect the normal procedures for compounding of interest in the loan account.

Other Highlights of the Modified Norms:

Levying penal interest or charges is intended to guarantee that the lender is fairly compensated as well as to instill a sense of credit discipline in borrowers through disincentives.
The new guidelines are applicable to banks, including small finance banks, regional rural banks, but excluding payments banks, NBFCs, All India Financial Institutions such as Exim Bank, NABARD, SIDBI and NaBFID, etc.
Lenders will have to formulate a board approved policy on penal charges or similar charges on loans.
In the case of existing loans, the switchover to new penal charges regime shall be ensured on next review or renewal date or six months from the effective date of this circular, whichever is earlier.
The modified norms will not apply to credit cards, external commercial borrowings, trade credits and structured obligations which are covered under product specific directions.

Impact on Consumers:

Supervisory reviews have indicated divergent practices amongst the REs with regard to levy of penal interest/charges leading to customer grievances and disputes.
Now, REs will have to disclose the quantum and reason for penal charges clearly to the customers in the loan agreement and most important terms and conditions/Key Fact Statement (KFS).
These will also be displayed on the website of REs under interest rates and service charges section.

Q1) What is the National Bank for Financing Infrastructure and Development (NaBFID)?

The NaBFID is a specialised Development Finance Institution set up in 2021 by an Act of the Parliament. It aims to support the country’s infrastructure sector, which can significantly gain from an enabling credit flow by means of attractive instruments and channelised investment.

Q2) What is the difference between banks & NBFCs?

NBFCs lend and make investments and hence their activities are akin to that of banks; however, there are a few differences – NBFC cannot accept demand deposits; NBFCs do not form part of the payment and settlement system and cannot issue cheques drawn on itself; etc.