Skip to main content

Penal Charges in Loan Accounts

Reserve Bank of India (RBI) has issued draft circular on penal charges in loan accounts to ensure fair lending practice by the regulated entities.

Why are penal interest / charges levied?

  • The intent of levying penal interest / charges is essentially to inculcate a sense of credit discipline among borrowers through negative incentives and to ensure fair compensation to the lender. 
  • Penal interest / charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest. 

What is rationale behind the draft circular?

Under the extant guidelines, lending institutions have the operational autonomy with regard to levy of penal rates of interest. 

During supervisory reviews of regulated entities (REs) it was observed that –

  • Many REs use penal rates of interest, over and above the applicable interest rates, in case of defaults / non-compliance by the borrower with the terms on which credit facilities were sanctioned.
  • Divergent practices amongst the REs with regard to levy of penal interest / charges are leading to customer grievances and disputes.

What are the proposed instructions on penal charges in loan accounts?

On a review of the practices followed by REs for charging penal interest / charges on loans, the following instructions are issued for adoption.

  1. Determination of interest rates on credit facilities, including conditions for reset of interest rates, will be strictly governed by the relevant regulatory instructions issued in this regard. REs shall not introduce any additional component to rate of interest.
  2. Penalty, if charged, for default / non-compliance of material terms and conditions of loan contract by the borrower 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. 
  3. 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.
  4. It needs to be recognised 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.
  5. The quantum of penal charges shall be proportional to the defaults / non-compliance of material terms and conditions of loan contract beyond a threshold. This threshold is to be determined by the REs and shall not be discriminatory within a particular loan / product category.
  6. The penal charges in case of loans sanctioned to individual borrowers, for purposes other than business, shall not be higher than the penal charges applicable to non-individual borrowers.
  7. Penal charges and the conditions precedent therefor, shall be clearly disclosed by REs to the customers in the loan agreement and most important terms & conditions / Key Fact Statement (KFS) as applicable, in addition to being displayed on REs website under Interest rates and Service Charges.
  8. Whenever reminders for payment of instalments are sent to borrowers, the applicable penal charges, shall also be communicated.
  9. The REs shall ensure that there is a clearly laid down Board approved policy on penal charges or similar charges on loans, by whatever name called.
  10. The operationalisation of the ‘penal charges’ in place of ‘penal interest’ will be subject to appropriate review during supervisory examination by the RBI.

Which products are exempted from the purview of the proposed instructions?

The instructions will not apply to Credit Cards which are covered under product specific directions.


References

Reserve Bank of India. (2023, April 12). 'Draft Circular on Fair Lending Practice - Penal Charges in Loan Accounts'. Retrieved from https://www.rbi.org.in/Scripts/bs_viewcontent.aspx?Id=4254

Reserve Bank of India. (2023, April 12). 'RBI releases Draft Circular on Fair Lending Practice - Penal Charges in Loan Accounts'. Retrieved from https://www.rbi.org.in/Scripts/BS_PressReleaseDisplay.aspx?prid=55506


Follow at - Telegram   Instagram   LinkedIn   Twitter   Facebook

Labels:

Comments

Post a Comment

Popular Posts

Modified Interest Subvention Scheme for Agricultural Loans

Reserve Bank of India (RBI) has published the modified interest subvention scheme (MISS) for short term loans for agriculture and allied activities availed through Kisan Credit Card (KCC) during the financial year 2025-26. Which loans are covered under modified interest subvention scheme (MISS)? The short-term crop loans and short-term loans for allied activities including animal husbandry, dairy, fisheries, bee keeping etc. up to an overall limit of ₹3 lakh to farmers through KCC during the year 2025-26 will be covered for interest subvention. Which lending institutions are covered under MISS? The MISS is applicable to the lending institutions viz. Public Sector Banks (PSBs) and Private Sector Banks (in respect of loans given by their rural and semi-urban branches only), Small Finance Banks (SFBs) and computerized Primary Agriculture Cooperative Societies (PACS) ceded with Scheduled Commercial Banks (SCBs), on use of their own resources.  How much is the interest subvention? The a...
Post a Comment
Read more

Reserve Bank - Integrated Ombudsman Scheme, 2026 (RB-IOS, 2026)

Reserve Bank of India (RBI) has issued Reserve Bank - Integrated Ombudsman Scheme, 2026. Who is RBI Ombudsman and RBI Deputy Ombudsman? RBI may appoint one or more of its officers as RBI Ombudsman and RBI Deputy Ombudsman, to carry out the functions entrusted to them under the Reserve Bank - Integrated Ombudsman Scheme (RB-IOS).  The appointment of RBI Ombudsman or RBI Deputy Ombudsman shall be for up to 3 years at a time. RBI Ombudsman shall have the power to examine and close all complaints.   RBI Deputy Ombudsman shall have the power to close those complaints falling under clause 10 of the RB-IOS (i.e. non-maintainable complaints) and complaints resolved as per the provisions of the clause 14(8)(a) to 14(8)(c) of the RB-IOS (i.e. complaint resolved / withdrawn). Which entities are covered under the RB-IOS? RB-IOS shall be applicable to the following Regulated Entities (REs) – Commercial Banks Regional Rural Banks  State Co-operative Banks Central Co-operative Bank...
Post a Comment
Read more

Internal Ombudsman for Regulated Entities (Banks, NBFCs, PPI Issuers and CICs)

Reserve Bank of India (RBI) has issued directions on Internal Ombudsman for regulated entities. To whom shall the directions on Internal Ombudsman (IO) be applicable? The directions on IO shall be applicable to the following Regulated Entities (REs) – Commercial Banks (other than Small Finance Banks, Payment Banks, and Local Area Banks) having 10 or more banking outlets in India as on March 31, 2025, whether such bank is incorporated in / outside India Small Finance Banks having 10 or more banking outlets in India as on March 31, 2025 Payments Banks having 10 or more banking outlets in India as on March 31, 2025 Non-Banking Financial Companies (NBFCs) fulfilling the following criteria as on March 31, 2025 – Deposit-taking NBFCs (NBFCs-D) with 10 or more branches Non-Deposit taking NBFCs (NBFCs-ND) with asset size of ₹5,000 crore and above and having public customer interface Non-Bank Prepaid Payment Instruments Issuers having more than 1 crore Prepaid Payment Instruments (PPIs) outstan...
Post a Comment
Read more

Financial Literacy Week (FLW) 2026

Reserve Bank of India (RBI) has observed financial literacy week from February 09 to 13, 2026. Financial Literacy and Financial Education Organization for Economic Co-operation & Development (OECD) defines ‘financial literacy’ as a combination of financial awareness, knowledge, skills, attitude and behaviour necessary to make sound financial decisions and ultimately achieve individual financial well-being.  OECD defines ‘financial education’ as the process by which financial consumers / investors improve their understanding of financial products, concepts and risks and through information, instruction and / or objective advice, develop the skills and confidence to become more aware of financial risks and opportunities, to make informed choices, to know where to go for help and to take other effective actions to improve their financial well-being. Financial Literacy Week (FLW) Reserve Bank of India (RBI) has been observing Financial Literacy Week (FLW) every year since 2016 to p...
Post a Comment
Read more

What is Reserve Bank of India – Digital Payments Index (RBI-DPI)? (Updated on February 12, 2026)

There have been continuous efforts by various stakeholders for digitization of payments in the country. But how to we measure the impact of these efforts?  What is Reserve Bank of India – Digital Payments Index (RBI-DPI)? Reserve Bank of India (RBI) has constructed a composite Digital Payments Index (DPI) to capture the extent of digitization of payments across the country. What are the parameters of RBI-DPI? The RBI-DPI comprises of five broad parameters that enable measurement of deepening and penetration of digital payments in the country over different time periods. These parameters along with their weights in the RBI-DPI are as follows –  Payment Enablers (25%) Payment Infrastructure – Demand-side factors (10%) Payment Infrastructure – Supply-side factors (15%) Payment Performance (45%) Consumer Centricity (5%).  Each of these parameters have sub-parameters which, in turn, consist of various measurable indicators.  What is the base year for RBI-DPI? The RBI-DPI ...
Post a Comment
Read more