The Reserve Bank of India (RBI) has recently proposed to prohibit capitalisation of penal charges and additional interest levied by banks on customers for loan defaults. The quantum of penal charges should be proportional to the defaults/non-compliance of material terms and conditions of loan contract up to a threshold, RBI said in its draft circular on 'Fair Lending Practice - Penal Charges in Loan Accounts'.
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What this essentially means?
Lending institutions have the operational autonomy to formulate board-approved policy for levy of penal rates of interest under the extant of RBI's guidelines. However, many RBI regulated entities (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.
With RBI's draft paper, this practice might be streamlined.
RBI said that 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.
However, the central bank observed that divergent practices are ongoing amongst the REs with regard to levy of penal interest/charges leading to customer grievances and disputes.
What will RBI do now?
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, RBI said.
What are the current norms?
Currently, there are no guidelines on how much penal interest can be charged by banks. So, it may vary across banks, and other lenders. These charges are levied when borrowers miss or delay repayments of EMIs on time, or in case of cheque bounces, for pre-payment of loans, among other cases.
What happens now?
As the draft guidelines are out, the RBI has now invited comments from various stakeholders such as borrowers, banks and other institutions and after the discussion process, it will issue final guidelines.
The new rules would be applicable to all entities regulated by the RBI, including all commercial banks, co-operative banks, NBFCs (including housing finance companies), and All India Financial Institutions like EXIM Bank, NABARD, NHB, SIDBI and NaBFID. These rules, however, will not apply to credit cards.
(Edited by : C H Unnikrishnan)
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