Skip to main content

Penal Charges in Loan Accounts

Reserve Bank of India (RBI) has issued 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 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.

In view of the above observations, Reserve Bank of India (RBI) had issued draft circular on penal charges in loan accounts for comments by the stakeholders. RBI has now released the instructions on penal charges in loan accounts.

What are the 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. Penalty, if charged, for 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.
  2. 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.
  3. REs shall not introduce any additional component to the rate of interest and ensure compliance to these guidelines in both letter and spirit.
  4. REs shall formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called.
  5. The quantum of penal charges shall be reasonable and commensurate with the non-compliance of material terms and conditions of loan contract without being 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 for similar non-compliance of material terms and conditions.
  7. The quantum and reason for penal charges 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 non-compliance of material terms and conditions of loan are sent to borrowers, the applicable penal charges shall be communicated. Further, any instance of levy of penal charges and the reason therefor shall also be communicated.

Which banks / institutions will be covered under the instructions?

  • All Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks, excluding Payments Banks)
  • All Primary (Urban) Co-operative Banks
  • All NBFCs [including Housing Finance Companies (HFCs)]
  • All India Financial Institutions (AIFIs) –
    • Export-Import Bank of India (EXIM Bank)
    • National Bank for Agriculture and Rural Development (NABARD)
    • National Housing Bank (NHB) 
    • Small Industries Development Bank of India (SIDBI) 
    • National Bank for Financing Infrastructure and Development (NaBFID)

Which loans will be covered by the instructions?

The instructions on penal charges in loan accounts will be applicable in respect of all the fresh loans availed / renewed from the effective date. 

Which products are exempted from the purview of the instructions?

The instructions will not apply to Credit Cards, External Commercial Borrowings, Trade Credits and Structured Obligations which are covered under product specific directions.

From when are the instructions applicable?

(Updated January 17, 2024)

The instructions were to come into effect from January 01, 2024 but the timeline has been extended by 3 months. 

Accordingly, REs shall ensure that the instructions are implemented in respect of all the fresh loans availed from April 01, 2024 onwards. In the case of existing loans, the switchover to new penal charges regime shall be ensured on the next review / renewal date falling on or after April 01, 2024, but not later than June 30, 2024.


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, August 18). 'Fair Lending Practice - Penal Charges in Loan Accounts'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12527&Mode=0

Reserve Bank of India. (2023, December 29). 'Fair Lending Practice - Penal Charges in Loan Accounts: Extension of Timeline for Implementation of Instructions'. Retrieved from https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12585&Mode=0

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

Reserve Bank of India. (2024, January 15). 'FAQ - Fair Lending Practice - Penal Charges in Loan Accounts'. Retrieved from https://www.rbi.org.in/Scripts/FAQView.aspx?Id=162


Follow at - Telegram   Instagram   LinkedIn   Twitter   Facebook

Labels:

Comments

Post a Comment

Popular Posts

Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) (Updated as on September 11, 2026)

Reserve Bank of India (RBI) has issued the directions on maintenance of Cash Reserve Ratio (CRR) and Statutory Liquidity Ratio (SLR) by banks. To whom are the directions applicable? The directions are applicable to the following Regulated Entities (REs) – Commercial Banks  Small Finance Banks (SFBs) Payments Banks (PBs) Local Area Banks (LABs) Regional Rural Banks (RRBs) Primary (Urban) Co-operative Banks (UCBs) Rural Co-operative Banks – State Co-operative Banks (StCBs) District Central Co-operative Banks (DCCBs) What is CRR? Every bank shall maintain in India by way of cash reserve, a sum equivalent to such percent of its Net Demand and Time Liabilities (NDTL) in India, as the RBI in terms of Section 42(1) of the RBI Act, 1934 (for scheduled banks) and Section 18(1) of the Banking Regulation Act (BR Act), 1949 (for non-scheduled banks) [including provisions of Section 18(1) of the BR Act as applicable to co-operative banks], may specify. What is incremental CRR? In terms of Secti...
Post a Comment
Read more

What is Ways and Means Advances (WMA)? (Updated as on September 25, 2026)

Reserve Bank of India (RBI) has recently announced the Ways and Means Advances (WMA) limit for the Government of India. So, what is WMA? What is Ways and Means Advances (WMA)? Ways and Means Advances (WMA) is a collateral free clean advance availed by the Central and State Governments from RBI, to tide over temporary mismatches in the receipts and payments. Section 17(5) of the Reserve Bank of India Act, 1934 empowers RBI to grant WMA to Central and State Governments, as and when required by them. What is Special WMA / Special Drawing Facility (SDF)? In addition to WMA, State Governments are also eligible for a Special Drawing Facility (SDF), which is granted against collateral of Government Securities held by the State Governments.  SDF availed by State Governments / UTs is linked to the quantum of their investments in marketable securities issued by the Government of India, including Auction Treasury Bills (ATBs).  (Updated as on June 28, 2024) Based on the recommendations m...
Post a Comment
Read more

Policies to be formulated by NBFC-BL

Non-Banking Financial Companies (NBFCs) are required to formulate various policies for effective corporate governance and operations. This article lists out some of the important policies to be formulated by the Base Layer NBFCs (NBFC-BL). Business Model Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 dated October 19, 2023 Para 1.1 of Annex II – In view of the criticality of the nature of the business model in determining the classification of financial assets and restrictions on subsequent reclassification, NBFCs are advised to put in place Board approved policies that clearly articulate and document their business models and portfolios. Para 1.2 of Annex II – NBFCs shall frame their policy for sales out of amortised cost business model portfolios. Expected Credit Losses (ECL) Policy Master Direction – Reserve Bank of India (Non-Banking Financial Company – Scale Based Regulation) Directions, 2023 dated October 19, 202...
Post a Comment
Read more

Framework for Self-Regulatory Organisations in the FinTech Sector (Updated on September 10, 2026)

Reserve Bank of India (RBI) has released the framework for self-regulatory organisations in the FinTech sector. What are FinTechs? For the purpose of membership of an Self-Regulatory Organisations for FinTech Sector (SRO-FT), FinTechs may be defined as entities that provide technological solutions for delivery of financial products and services to businesses and consumers or encompass regulatory and supervisory compliance in partnership with traditional financial institutions or otherwise.  What is the need of Self-Regulatory Organisations for FinTech Sector? FinTechs play a pivotal role in redefining financial services by saving time, enhancing access, and lowering costs. While the FinTechs bring various innovations, the FinTech sector also raises concerns relating to customer protection, data privacy, cyber security, grievance handling, internal governance, financial system integrity, etc. A judicious balance between maximising the creative potential of FinTechs, while minimising...
Post a Comment
Read more

Credit Derivatives (Updated as on September 22, 2026)

Reserve Bank of India (RBI) has issued directions on credit derivatives. What is Credit Derivative? Credit derivative means a derivative contract whose value is derived from the credit risk of an underlying debt instrument or an index of underlying debt instruments. What is Credit Default Swap (CDS) and Total Return Swap (TRS)? Credit Default Swap (CDS) means a credit derivative contract in which one counterparty (protection seller) commits to pay to the other counterparty (protection buyer) in the case of a credit event with respect to a reference entity and in return, the protection buyer makes periodic payments (premium) to the protection seller until the maturity of the contract or the credit event, whichever is earlier. Total Return Swap (TRS) means a credit derivative contract under which one counterparty (total return payer) commits to transfer the entire economic performance of a reference asset to the other counterparty (total return receiver), and, in return, receives a pre-d...
Post a Comment
Read more