New Delhi: On Wednesday, the Reserve Bank of India (RBI) issued draft norms aimed at prohibiting banks from capitalizing penal charges and additional interest levied on customers for loan defaults. This proposal aims to standardize the divergent practices that different lenders have been following. The RBI has invited comments from stakeholders by May 15.
Under current guidelines, lending institutions have the autonomy to formulate a board-approved policy for the levy of penal rates of interest. The RBI noted that many regulated entities (REs) use penal rates of interest over and above applicable interest rates in the case of borrower defaults and non-compliance with credit facility terms.
The RBI aims to discourage lenders from using penal charges as a “revenue enhancement tool.” The draft norms state that if a penalty is charged for a default or non-compliance with the material terms and conditions of a loan contract, it should be treated as ‘penal charges’ and not levied in the form of ‘penal interest.’ Penal charges should not be capitalized, meaning that no further interest should be computed on such charges. The RBI added that this would not affect the normal procedures for compounding interest in the loan account.
The quantum of penal charges should be proportional to the defaults or non-compliance of material terms and conditions of a loan contract beyond a threshold. This threshold is to be determined by lenders and should not be discriminatory within a particular loan or loan product category.
Moreover, the penal charges in case of loans sanctioned to individual borrowers for purposes other than business should not be higher than the penal charges applicable to non-individual borrowers.
“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… These instructions shall come into effect from a date to be indicated in the final circular, and REs may carry out appropriate revisions in their policy framework and ensure implementation from the effective date,” the RBI said.
The RBI aims to streamline and standardize the practices of lenders in relation to penal charges, as there is currently no uniformity in the charges levied by different lenders. The RBI intends to ensure that penal charges are levied in a fair and proportional manner and not used as a source of additional revenue. The RBI’s draft norms aim to promote transparency and fairness in the credit market, and its decision to invite comments from stakeholders reflects its commitment to a consultative process.