ET Explainer: What RBI's norms on penal charges mean for borrowers

RBI has barred banks and finance companies from charging penal interest, often levied on customers for delays in payment of equated monthly instalments (EMI). Also, lenders cannot introduce additional components to the rate of interest as a substitute. RBI has allowed a lender to levy penal charges; however, banks must ensure that there is no capitalisation of the penal charges and no further interest computed on such charges.

Why were these guidelines issued?

The intent behind levying penal interest and charges is to inculcate a sense of credit discipline. These charges are not meant to be used as a revenue enhancement tool. However, RBI's supervisory review found that banks and finance companies impose penalties and charges to enhance their income, leading to customer grievances and disputes.

What is the difference between penal charges and penal interest?

In case of default or non-compliance, the lenders would often impose penalties in the form of penal charges and penal interest rates. A penal charge is a fixed payment charge and not added to the interest, while penal interest is a rate added to the existing interest rate charged to the customer. The RBI also directed banks not to capitalise penal charges and no further interest should be computed on such charges.

When will these guidelines come into effect?

For all the new loans, the guidelines come into effect from April 1, while for all the existing loans, the norms will be effective from June 1, 2024. The RBI has already extended the implementation date from January 1 to April 1.

Are the guidelines the same for retail and corporate borrowers?

Yes, retail and corporate borrowers will have the same penalty charged for the same loan product.

How will a lender decide on the quantum of penal charge?

Banks will levy charges on the amount classified as default. The RBI has asked lenders to levy charges in a non-discriminatory manner, as per their board-approved policy. The RBI has also told lenders that penal charges shall be reasonable, but they have not set any cap on the charges.

Are the new norms applicable to other ?

The new norms apply to securitisation and co-lending portfolios. However, they do not apply to rupee/ foreign currency export credit and other foreign currency loans. In the case of non-performing loan accounts, the RBI has asked banks to reverse the accrued income if it has remained uncollected.