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

Highlights of RBI Annual Report 2023-24 – Chapter 7 to 12

Reserve Bank of India (RBI) has published its annual report for the financial year 2023-24. In a series of articles, we will go through the highlights of the report. This is the fifth and last article in the series.  Chapter 7 – Public Debt Management Ways And Means Advances (WMA) limit for the Government of India (GoI) for H1:2023-24 (April to September 2023) was fixed at ₹1,50,000 crore and for H2:2023-24 (October 2023 to March 2024) was fixed at ₹50,000 crore. RBI issued an ultra-long security of 50-year tenor aggregating ₹30,000 crore to cater to the growing needs of long-term institutional players. Issuance of Sovereign Green Bonds (SGrBs) for an aggregate amount of ₹20,000 crore included maiden issuance of 30-year (₹10,000 crore) SGrB in addition to 5-year (₹5,000 crore) and 10-year (₹5,000 crore) SGrBs. A new 3-year benchmark security was introduced as part of government market borrowing programme during H1:2023-24.  The basket of products offered through the ‘Retail ...
Post a Comment
Read more

RBI’s Monetary Policy (August 06, 2025): In A Nutshell

The bi-monthly monetary policy of Reserve Bank of India (RBI) was announced on August 06, 2025. Here are some of the highlights of the monetary policy announcement. Rates   Change Rate Policy repo rate Unchanged 5.50% Standing deposit facility (SDF) rate 5.25% Marginal standing facility (MSF) rate 5.75% Bank rate 5.75% Monetary policy stance Monetary policy stance unchanged as ‘neutral’. Domestic Economy  Real GDP growth for 2025-26 is projected at 6.5%. CPI headline inflation declined for the eighth consecutive month to a 77-month low (since January 2019) of 2.1% in June, driven primarily by a sharp decline in food inflation. Food inflation recorded its first negative print since February 2019 at (-) 0.2% in June. CPI inflation for 2025-26 is projected at 3.1%. India’s current account deficit (CAD) moderated to 0.6% of GDP in 2024-25 from 0.7% of GDP in 2023-24 due to robust services exports and strong remittances receipts despite higher merchandise trade deficit. As on Augus...
Post a Comment
Read more

Non-Fund Based Credit Facilities

Reserve Bank of India (RBI) has issued directions on non-fund based credit facilities. To whom shall the directions be applicable? The directions shall apply to the following Regulated Entities (REs) for all their Non-Fund Based (NFB) exposures such as guarantee, letter of credit, co-acceptance etc. Commercial Banks (including Regional Rural Banks and Local Area Banks) Primary (Urban) Co-operative Banks (UCBs) / State Co-operative Banks (StCBs) / Central Co-operative Banks (CCBs) All India Financial Institutions (AIFIs) Non-Banking Financial Companies (NBFCs) including Housing Finance Companies (HFCs) in Middle Layer and above, only for the issuance of Partial Credit Enhancement. The directions shall not apply to the derivative exposures of a RE. Which NFB facilities are permitted to be issued by RE? RE shall issue a NFB facility only on behalf of a customer having funded credit facility from the RE. However, this shall not be applicable in respect of – Derivative contracts entered int...
Post a Comment
Read more

Co-Lending Arrangements (CLAs)

Reserve Bank of India (RBI) has issued directions on co-lending arrangements which will replace the existing guidelines on co-lending by banks and Non-Banking Financial Companies (NBFCs) to priority sector. What is Co-Lending Arrangement (CLA)? Co-Lending Arrangement (CLA) refers to an arrangement, formalised through an ex-ante agreement, between a regulated entity (RE) which is originating the loans (‘originating RE’) and another RE which is co-lending (‘partner RE’), to jointly fund a portfolio of loans, comprising of either secured or unsecured loans, in a pre-agreed proportion, involving revenue and risk sharing. To whom shall the directions be applicable? The directions shall be applicable to CLAs entered into by the following REs – Commercial Banks (excluding Small Finance Banks, Local Area Banks and Regional Rural Banks) All-India Financial Institutions Non-Banking Financial Companies (including Housing Finance Companies) Which lending arrangements are exempt from the applicabil...
Post a Comment
Read more

Investment in Alternative Investment Funds (AIFs)

Reserve Bank of India (RBI) has issued directions for investment in Alternative Investment Funds (AIFs) which will replace the existing guidelines . To whom shall the directions be applicable? The directions shall be applicable to investments by the following regulated entities (REs) in units of AIF Schemes – Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks) Primary (Urban) Co-operative Banks / State Co-operative Banks / Central Co-operative Banks All-India Financial Institutions Non-Banking Financial Companies (including Housing Finance Companies) What shall be the limits for investment in AIF schemes? No RE shall individually contribute more than 10% of the corpus of an AIF Scheme. Collective contribution by all REs in any AIF Scheme shall not be more than 20% of the corpus of that scheme. Outstanding investments or commitments of a RE, made with prior approval from RBI under the provisions of Master Direction – Reserve Bank of India (Financi...
Post a Comment
Read more