Fresh rules to regulate the panel charges on loans

The Reserve Bank of India (RBI) has issued instructions for penal charges in loan accounts to provide transparency in the disclosure of penal charges and interest rates in loan accounts. The guidelines for Penal charges in loan accounts have been effective from 1 January 2024.

Regulated Entities have used 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 have been approved.

The intent of charging penal is essential to plant a sense of credit discipline, and such interest is not about to be used as a revenue enhancement tool over and above the contracted rate of interest.

Fresh guidelines issued by RBI on loans-

#1 Penalty, if charged, for non-compliance of material terms and conditions of the loan contract by the borrower shall be displayed in the ‘penal charges’ and are not charged in the form of ‘penal interest’ that is added to the rate of interest charged on the advances.

For instance, there will be no further interest added to such charges. This will not affect the regular procedures for compounding interest (interest you earn on interest) in the loan account.

#2 The REs do not introduce any additional component to the rate of interest and ensure compliance with these guidelines in both letter and spirit.

#3 The Regular Entities ( REs) have formulated a Board-approved policy on penal charges or similar charges on loans, whatever you can call it.

#4 The quantum of penal charges is reasonable and proportional to the non-compliance of material terms of conditions of the loan contract without being discriminatory within a particular loan/product category.

#5 In case, the penal charges of loans approved to ‘individual borrowers, for purposes other than business, must be not higher than the penal charges applicable to non-individual borrowers.

#6 The quantum and reason for penal charges have been disclosed by REs to the customers in the loan agreement and most important terms and conditions.

#7 The issued terms and conditions of material terms for non-compliance with the loan are sent to borrowers, and the appropriate penal charges can be communicated.

Important details: the new rules were regulated by RBI on 1 January 2024 and that would apply to all banking entities regulated by the RBI. Under the RBI instructions, including all commercial banks, cooperative banks, NBFCs, housing finance companies, and All India Financial Institutions like EXIM Bank, NABARD, NHB, SIDBI, and NaBFID.

Point to be noted, these instructions do not apply to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations that are covered under product-specific directions.