RBI: Lenders are prohibited from imposing penalties on loans.
The Reserve Bank of India (RBI) announced on Friday that banks are not allowed to utilize penalties imposed on borrowers who default on loans as a means of raising funds. To ensure compliance with this directive, the central bank has amended regulations pertaining to loan accounts.
The RBI clarified that banks must categorize penalties for non-compliance as “penal charges” and not as “penal interest” added to the interest rate applied to the loans. The circular emphasized that these penal charges should not be used to calculate additional interest, effectively preventing the capitalization of such charges.
The circular also stipulated that these instructions will not impact the standard processes for interest compounding within loan accounts. The decision to issue these directions stemmed from the observation that numerous banks were imposing penal rates of interest beyond the applicable interest rates when borrowers defaulted or failed to comply with the terms of the sanctioned credit facilities.
The central bank stressed that such charges are not intended to function as a means of generating extra revenue beyond the contracted interest rate. This move by the RBI is noteworthy, given that customers have frequently expressed concerns about the lack of transparency in how banks apply penal charges to their accounts.
The RBI’s circular underlines the importance of maintaining fairness in penal charges, ensuring that they are reasonable and proportionate to the level of non-compliance with the material terms and conditions of the loan contract.
