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June, 15

Penalty can only take the form of charges, not interest: RBI.

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Mumbai: The Reserve Bank of India has said that banks and finance companies cannot impose penal interest rates for non-fulfilment of loan conditions; they can only impose an additional penal charge.
The revised norms now include a new section that defines penal charges in loan accounts. Lenders must disclose the penal charges for late repayment in bold within the loan agreement, while finance companies must convey these charges in the vernacular language the borrower understands. The new guidelines will ensure that lenders do not change the contracted interest rates for borrowers if they miss out on installments.
“The intent of levying penal interest/charges is primarily to instil a sense of credit discipline; such charges are not intended to serve as a revenue enhancement tool beyond the contracted interest rate. However, supervisory reviews have revealed divergent practices among the REs regarding the imposition of penal interest/charges, leading to customer grievances and disputes,” the RBI stated in a circular.
One implication of the change is terminology is that lenders cannot capitalizing penal charges (charging interest on these charges). Lenders must establish a board-approved policy on penal charges, ensuring transparency, reasonable charges, and clear disclosure to borrowers.
Previously, the Finance Industry Development Council had appealed to the RBI not to classify penal interest as ‘charges’ due to tax implications. “Adjusting the credit risk premium can be considered when there is a significant drop in the risk profile, and this can be implemented after a thorough review of the profile based on various parameters. On the other hand, penal interest can be levied from the date of default, which discourages unnecessary delays by borrowers,” the council had conveyed.





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