RBI’s Draft Guidelines Proposes to Prohibit Capitalization of Penalties on Loan Defaults

Press Release: 2023-2024/56, dated 12.04.2023

Earlier, the RBI announced in the Statement on Developmental and Regulatory Policies dated 08.02.2023 regarding the review of extant regulatory guidelines on levy of penal interest. Now, the RBI has released the Draft Circular on Fair Lending Practice – Penal Charges in Loan Accounts.

As per the draft circular, penalties for default in repayment of loan must be treated as penal charges, rather than a penal rate of interest on the loan amount. Also, there shall be no capitalisation of penal charges, i.e, no further interest will be computed on such charges

The key takeaways of the RBI’s draft circular are as follows –

(a) Regulated Entities (REs) to be prohibited from introducing additional components to interest rates

(b) Penalties for default to be treated as ‘penal charges’ rather than ‘penal interest’

(c) Recognition of Credit Risk Premium in Loan Interest Rates

(d) Proportionate penal charges to be levied for breaches beyond loan default threshold

(e) Penal charges for loans granted to individual borrowers not to exceed charges levied on non-individual borrowers

(f) RBI recommends communication of applicable penal charges to borrowers

(g) Regulated Entities (REs) to ensure mandatory Board-approved policy on penal charges for loans

Click Here To Read The Full Press Release