RBI To Stop Banks From Capitalising Penal Charges on Loans Defaults

Mumbai, April 12: The Reserve Bank of India on Wednesday proposed to prohibit capitalisation of penal charges and additional interest levied by banks on customers for loan defaults, in a bid to streamline divergent practices followed by lenders.

The quantum of penal charges should be proportional to the defaults/non-compliance of material terms and conditions of loan contract up to a threshold, said its draft circular on 'Fair Lending Practice - Penal Charges in Loan Accounts'. RBI Has Directed Banks to Print ‘Gita Saar’ on Last Page of the Passbook of All Account Holders? PIB Fact Check Reveals Truth Behind Fake Post.

Under the extant RBI's guidelines, lending institutions have the operational autonomy to formulate board-approved policy for levy of penal rates of interest. RBI Lifts Ban on American Express Onboarding New Customers in India.

However, many RBI regulated entities (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. Now, the central bank has issued drafts on 'Fair Lending Practice - Penal Charges in Loan Accounts' to streamline the practices.

"The intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline among borrowers through negative incentives and to ensure fair compensation to the lender.

"Penal interest/charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest," the draft said. However, it added supervisory reviews have indicated divergent practices amongst the REs with regard to levy of penal interest/charges are leading to customer grievances and disputes.

The draft says: "Determination of interest rates on credit facilities, including conditions for reset of interest rates, will be strictly governed by the relevant regulatory instructions issued in this regard. REs shall not introduce any additional component to rate of interest."

Penalty, if charged, for default/non-compliance of material terms and conditions of loan contract by the borrower should be treated as 'penal charges' and should not be levied in the form of 'penal interest' that is added to the rate of interest charged on the advances, it said.

"There shall be no capitalisation of penal charges, i.e, no further interest computed on such charges. However, this will not affect the normal procedures for compounding of interest in the loan account," the draft added.

RBI further said it needs to be recognised that the rate of interest on a loan includes appropriate credit risk premium reflecting the credit risk profile of the borrower.

"If the credit risk profile of the borrower undergoes change, REs will be free to alter credit risk premium as per the contracted terms and conditions, in terms of extant instructions," it said.

Also, the penal charges in case of loans sanctioned to individual borrowers, for purposes other than business, should not be higher than the penal charges applicable to non-individual borrowers.

"Whenever reminders for payment of instalments are sent to borrowers, the applicable penal charges shall also be communicated," it stressed. The proposed instructions would not apply to credit cards which are covered under product specific directions, the draft added. The RBI has invited comments from the stakeholders by May 15.

(This is an unedited and auto-generated story from Syndicated News feed, LatestLY Staff may not have modified or edited the content body)