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 2025-26 – Chapter 1 to 3

Reserve Bank of India (RBI) has published its annual report for the financial year 2025-26. In a series of articles, we will go through the highlights of the report. This is the first article in the series.  Legal framework for publication of Annual Report by the RBI Report of the Central Board of Directors on the working of RBI for the year is submitted to the Central Government in terms of Section 53(2) of the RBI Act, 1934. The letter of transmittal is signed by the RBI Governor and addressed to the Finance Secretary, Ministry of Finance, Government of India. Documents submitted by the RBI to the Central Government In pursuance of Section 53(2) of the RBI Act, 1934, the following documents have been submitted to the Central Government – A copy of the Annual Accounts for the year ended March 31, 2026 certified by the RBI’s Auditors and signed by Chief General Manager-in-charge, all the Deputy Governors and Governor. 2 copies of the Annual Report of the Central Board on the workin...
Post a Comment
Read more

Trade Receivables Discounting System (TReDS)

Reserve Bank of India (RBI) has issued the directions on Trade Receivables Discounting System (TReDS). What is TReDS? TReDS is a technology platform on a digital or electronic network for facilitating factoring of trade receivables through multiple financiers. What is a Factoring Unit? Factoring unit refers to trade receivable in the form of invoice / bill uploaded either by the seller (in the case of factoring) or by the buyer (in case of reverse factoring), as the case may be. Who are the participants in TReDS? Seller – Micro, Small and Medium Enterprise (MSME) Buyer – any person liable to the seller, whether under a contract or otherwise, against an invoice or bill of exchange, to pay any trade receivable Financier – all entities / institutions permitted to undertake factoring business under the Factoring Regulation Act, 2011 Insurance companies  Credit Guarantee Fund Trust notified by the Government of India Who can operate TReDS platforms? An entity shall seek authorisation fr...
Post a Comment
Read more

Highlights of RBI Annual Report 2025-26 – Chapter 6 (Part I)

Reserve Bank of India (RBI) has published its annual report for the financial year 2025-26. In a series of articles, we will go through the highlights of the report. This is the third article in the series.  Chapter 6 – Regulation, Supervision and Financial Stability (Part I) Opening of and operation in deposit accounts of minors by banks – Minors of any age can open and operate savings and term deposit accounts through his / her natural or legal guardian or with mother as guardian.  Minors above the age of 10 years may open and operate savings and term deposit accounts independently, if they so desire. Digital lending guidelines – Regulated Entities (REs) were mandated to ensure that lending service providers (LSPs) display all loan offers to borrowers when multiple lenders are involved.  A public directory of Digital Lending Apps (DLAs) was introduced to help borrowers verify their link with REs. Non-Banking Financial Companies (NBFCs) were allowed to consider Default...
Post a Comment
Read more

Highlights of RBI Annual Report 2025-26 – Chapter 4 & 5

Reserve Bank of India (RBI) has published its annual report for the financial year 2025-26. In a series of articles, we will go through the highlights of the report. This is the second article in the series.  Chapter 4 – Credit Delivery and Financial Inclusion The limit for collateral free loans to Micro and Small Enterprises (MSEs) was enhanced from ₹10 lakh to ₹20 lakh. The RBI was involved with the nationwide campaign, ‘Aapki Poonji, Aapka Adhikar’ (Your Money, Your Right), conducted during October-December 2025 to facilitate the return of unclaimed deposits and timely settlement of eligible claims from the Depositor Education and Awareness (DEA) Fund. During the campaign, ₹2,876 crore of unclaimed deposits were settled by public sector banks and regional rural banks. Expanding and Deepening of Digital Payments Ecosystem (EDDPE) programme  The programme aims to provide every eligible individual in the identified districts at least one mode of digital payment, viz., debit / ...
Post a Comment
Read more

Transfer of Surplus by the RBI to the Government

The surplus payable by the Reserve Bank of India (RBI) to the Central Government for the financial year 2025-26 amounted to ₹2,86,588.46 crore.  Why does the RBI transfer the surplus amount to the Central Government? As per section 47 of the RBI Act, 1934, after making provision for bad and doubtful debts, depreciation in assets, contributions to staff and superannuation funds and other provisions, the balance of the profits of the RBI is required to be paid to the Central Government. Also, the Central Government holds 100% of the share capital of the RBI. How much risk provision is required to be maintained by the RBI? The RBI developed the Economic Capital Framework (ECF) during 2014-15 and 2015-16 for determining the appropriate level of risk provisions to be made under the provisions of section 47 of the RBI Act, 1934.  In November 2018, the RBI, in consultation with the Government, constituted an Expert Committee to review the ECF of the RBI (Chairman: Dr. Bimal Jalan, fo...
Post a Comment
Read more