New Delhi:The Reserve Bank of India, which regulates the banking sector in the country, has issued fresh directions to banks, non-banking finance companies and housing finance companies on the levy of penal interest and penal charges on home loans, auto loans and personal loans in order to bring transparency and reduce customer grievances and disputes.
In its direction to banks, NBFCs, housing finance companies, regional rural banks, local area banks, urban-cooperative banks and national financial institutions such as National Housing Bank, NABARD and SIDBI among others, the RBI asked them to ensure reasonableness and transparency in disclosure of penal interest.
Under the existing guidelines, lending institutions have the operational autonomy to formulate Board approved policies for the levy of penal rates of interest. The RBI said that in many instances banks and NBFCs use penal rates of interest, over and above the applicable interest rates, in case of defaults and non-compliance by the borrower with the terms of loans.
According to the RBI, the intent behind the levy of penal interest and penal charges is to inculcate a sense of credit discipline and such charges should not be used as a revenue enhancement tool over and above the contracted rate of interest. However, it has been observed that banks and NBFCs and other regulated entities follow different practices with regard to the levy of penal interest or penalty that leads to customer grievances and disputes in the banking sector.
RBI guidelines on penal charges by banks
The RBI said if the penalty is levied for non-compliance with material terms and conditions of the loan contract by the borrower then shall be treated as a ‘penal charge’ and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the loan given to a customer.
In other words, there shall be no capitalisation of penal charges. It means there will be no further interest computed on such charges. For example, if a bank or NBFC levies a penalty for non-compliance with a loan agreement then it cannot levy interest on these charges. However, the RBI clarified that this will not affect the normal procedures for compounding interest in the loan account.
Moreover, banks, NBFCs and Housing Finance Companies will not introduce any additional component to the rate of interest. RBI also asked these regulated entities to formulate a Board approved policy on penal charges or similar charges on loans even if they are called by any other name.
Penal charges to be reasonable: RBI
More importantly, the Reserve Bank asked the bank and NBFCs to ensure that the quantum of penal charges shall be reasonable and commensurate with the non-compliance of material terms and conditions of loan contracts without being discriminatory within a particular loan or product category.
Secondly, the penal charges in case of loans sanctioned to individual borrowers, for purposes other than business, will not be higher than the penal charges applicable to non-individual borrowers for similar non-compliance of material terms and conditions.