Banks, NBFCs to stop compounding penalties from April 1, 2024
What's the story
The Reserve Bank of India (RBI) has pushed back the deadline, for implementing updated guidelines on penal interest and penalty charges for loan accounts, by three months.
These new rules will now apply to loan accounts opened on or after April 1, 2024, while existing loans must transition to the updated system by June 30, 2024.
The RBI aims to promote credit discipline among borrowers by imposing penal interest or charges.
Details
What led RBI to stop banks from compounding penal interests?
The central bank noticed that many banks were charging penal interest rates above the standard rates in cases of borrower defaults or non-compliance.
This led to inconsistent practices among banks and caused customer complaints and disputes.
The new guidelines were supposed to come into effect from January 1, 2024. However, considering that certain clarifications were needed in this regard and additional time was required by banks and NBFCs the implementation date is extended.
Insights
Key changes in the revised guidelines
In an August 2023 circular, the RBI clarified that penalties due to loan term non-compliance would be categorized as 'penal charges' rather than 'penal interest' added to the interest rate.
As a result, penal charges will not be capitalized, meaning no extra interest will be calculated on these charges.
For non-business loans granted to individual borrowers, the penal charges should not surpass those applied to non-individual borrowers for similar non-compliance.
What Next?
Disclosure and communication requirements for banks
Banks must clearly disclose the amount and reasoning behind penal charges in loan agreements and prominently display key terms and conditions on their websites.
When sending reminders for non-compliance to borrowers, banks should also communicate relevant penal charges.
Any imposition of penal charges and the rationale behind such actions must be transparently conveyed.
Banks are required to develop a board-approved policy on penal charges related to loans, adhering to both the literal interpretation and intended spirit of these guidelines.