Mumbai: Guidelines on the imposition of penal rates of interest on loans were issued by the Reserve Bank to banks and NBFCs. There would be no capitalization of criminal charges, which means that no additional interest will be computed on such costs, according to an RBI circular from the 18th of August 2023.
After examining the methods used by banks to assess penal interest and charges, the central bank issued guidelines emphasising that penalties for borrower non-compliance with loan contract terms and conditions should be treated as “penal charges” rather than “penal interest,” which is added to the rate of interest charged on advances. This won’t, however, change how interest is normally compounded in the loan account.
The RBI made it clear that the purpose of levying penal interest/charges is primarily to instill a sense of credit discipline and are not intended to be utilised as a tool for increasing revenue. The RBI further stated that the amount of penalties must be reasonable and cannot exceed the penalties that apply to non-individual borrowers when loans are granted to “individual borrowers, for purposes other than business.”
In the loan agreement, the banking companies must make explicit to the consumers the amount and justification of any penalties. These guidelines will take effect on January 1, 2024, although they do not apply to structured obligations, trade credits, credit cards, or external commercial borrowings.