Reserve Bank Tweaks Norms Of Penal Charges On Loan Accounts

The RBI said lenders must treat penalty for non-compliance as ‘penal charges’ and not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances

The RBI announced the change after observing that many banks use penal rates of interest, over and above the applicable interest rates, in case of defaults or non-compliance by the borrower with the terms on which credit facilities were sanctioned.

The Reserve Bank of India (RBI) on Friday tweaked the norms related to banks imposing penalties on loan accounts for violation of contractual terms by the borrower. According to the RBI release, banks cannot treat such penalties to raise revenues. "Under the extant guidelines, lending institutions have the operational autonomy to formulate Board approved policy for levy of penal rates of interest. It has been observed that many 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," the RBI statement read.

The central bank said lenders must treat penalty for non-compliance as ‘penal charges’ and not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances. There should not be capitalisation of penal charges, meaning no further interest computed on such charges, the RBI clarified, mentioning that this will not affect the normal procedures for compounding of interest in the loan account.

The RBI announced the change after observing that many banks use penal rates of interest, over and above the applicable interest rates, in case of defaults or non-compliance by the borrower with the terms on which credit facilities were sanctioned.

The release said while the intent of levying penal interest is essentially to inculcate a sense of credit discipline, supervisory reviews have indicated divergent practices amongst banks, the RBI said. "Such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest," the central bank said.

The RBI's observations are critical as customers have been complaining about lack of transparency on the part of banks while imposing penal charges on customers.

Meanwhile, the RBI's latest Bulletin on Thursday noted that the risk of stagflation currently in India remains very low, with a probability of only 3 per cent, notwithstanding a sharp pick-up in inflation. Stagflation is the phase when an economy faces moderation in GDP growth and high inflation.

An article on 'State of the Economy' in the August Bulletin also underlined that in this stressed global environment, the Indian economy is gathering momentum in the second quarter of 2023-24. Domestic drivers such as private consumption and fixed investment are offsetting the drag from the contraction in exports.