Home Loan, Personal Loan, Car Loan: Know How RBI Proposal On 'Penal Interest' Will Impact Borrowers

The central bank said the “divergent practices” by regulated entities with regard to the levy of penal interest have led to customer grievances and disputes have been seen.

With an aim to help borrowers, the Reserve Bank of India (RBI) has proposed to do away with the levy of ‘penal interest’ on loan defaults by regulated entities and replace it with ‘penal charges’. The central bank will issue draft guidelines on the issue for suggestions from stakeholders soon.

In the bi-monthly ’Statement on Developmental and Regulatory Policies’ released earlier, the RBI stated the “divergent practices” by regulated entities with regard to the levy of penal interest have led to customer grievances and disputes have been seen.

Why was penal interest levied?

“The intent of penal interest was essentially to inculcate a sense of credit discipline among borrowers through negative incentives but such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest,” the RBI said.

The RBI further raised concerns saying the supervisory reviews have indicated divergent practices amongst REs with regard to levy of penal interest which were excessive in certain cases, leading to customer grievances and disputes.

Why is RBI considering to replace with ‘penal charges’?

With regard to the issues above, the central bank has decided to replace “penal interest” with “penal charges”. “It has been decided that any penalty for delay/default in servicing of the loan or any other non-compliance of material terms and conditions of loan contract by the borrower shall be in the form of ‘penal charges’ in a reasonable and transparent manner and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest being charged on the advances,” the central bank said.

However, in case of any deterioration in the credit risk profile of the borrower, the regulated entities will be free to alter the credit risk premium under extant guidelines on the interest rate, RBI noticed.

How will RBI's decision help borrowers?

Experts from the banking and legal fraternity believe that the RBI’s proposal will immensely help loan customers.

A K Goel, Chairman of Indian Banks’ Association (IBA) told the publication The Financial Express that this could initiate uniform processes across the players so that the process is transparent and could benefit the customers.

Supreme Court Advocate Tushar Agarwal told the publication that many recovery cases are pending in courts and tribunals at the behest of banks where the borrowers have challenged the levy of excessive penal interest by bank on loans availed by them.

“In this scenario, the RBI decision on the issuance of draft guidelines on the levy of penal charges, will not only enhance the credibility of the banks but will also strengthen the trust of borrowers,” he added.