The Reserve Bank of India (RBI) has issued fresh guidelines to regulated entities (REs) such as commercial and other banks, NBFCs and other lenders to ensure reasonableness and transparency in disclosure of penal interest. 

This follows findings that many REs are using 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 intent of levying penal interest or charges is essentially to inculcate a sense of credit discipline, and such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest,” the RBI has said in a circular. 

“However, supervisory reviews have indicated divergent practices amongst the REs with regard to levy of penal interest or charges leading to customer grievances and disputes,” it has added. 

According to the new directive, penalty if charged for non-compliance with material terms and conditions of loan contract by the borrower would be treated as ‘penal charges’ and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances. 

“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 central bank has said in a circular. 

The REs have been asked not introduce any additional component to the rate of interest and ensure compliance to these guidelines in both letter and spirit. 

The REs will formulate a board-approved policy on penal charges or similar charges on loans, by whatever name it is called. 

The quantum of penal charges shall be reasonable and commensurate with the non-compliance with material terms and conditions of loan contract without being discriminatory within a particular loan or product category, the central bank has added.