Reserve Bank issued guidelines to banks, NBFCs on levying of penal rates of interest on loans. RBI in a circular dated 18th Aug 2023 mentioned that there shall be no capitalisation of penal charges i.e., no further interest computed on such charges.
After reviewing the practices followed by Banks on charging penal interest/charges, the central Bank issued the guidelines underscoring that Penalty, if charged, for non-compliance of terms and conditions of loan contract by the borrower shall 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. However, this will not affect the normal procedures for compounding of interest in the loan account.
RBI clarified that the intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline and are not meant to be used as a revenue enhancement tool.
RBI also said the quantum of penal charges shall be reasonable and in case of loans sanctioned to ‘individual borrowers, for purposes other than business’, shall not be higher than the penal charges applicable to non-individual borrowers.
The quantum and reason for penal charges shall be clearly disclosed by the Banking entities to the customers in the loan agreement.
These instructions shall come into effect from January 1, 2024 and are not applicable to Credit Cards, External Commercial Borrowings, Trade Credits and Structured Obligations.