Are banks making a business out of punishing loan defaulters?
Dec 20, 2023
Synopsis
The Reserve Bank of India (RBI) in August had instructing banks not to use penal interest rates as a revenue enhancement tool but rather to instill credit discipline. The RBI's guidelines are set to take effect on January 1, 2024. However, some banks seek a three-month deferral, arguing that penal interest rates promote better credit discipline. They also seek clarity on GST implications for penalties on stressed accounts.
RBI penal interestAgenciesThe RBI circular on penal interest is applicable to all commercial banks, small finance banks (except payment banks), NBFCs including Housing finance companies and other financial institutions such as SIDBI, EXIM banks etc.
There is a thin line between intending to accumulate more revenue and imposing penalty to instill credit discipline in borrowers. The Reserve Bank of India (RBI) had drawn the line in August when it told banks not to use penal interest rates to punish borrowers who fail to meet the terms and conditions of a loan contract.
Banks often increase the interest rate for non-compliant borrowers by 2-3% or even more on a case-by-case basis.
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 had said in a circular. The central bank had noted that supervisory reviews had indicated divergent practices amongst the banks with regard to the levy of penal interest/charges leading to customer grievances and disputes.
But now the banks have insisted that penal interest rates lead to better credit discipline.
What are penal interest rates?
The RBI had issued a circular in August on how banks can levy penalties on loan accounts. The guidelines came after it was observed that many banks use penal rates of interest, over and above the applicable interest rates, in case of default or non-compliance by the borrower with the terms on which loan was sanctioned. The new guidelines are to come into effect from January 1, 2024.
As per the RBI circular, penalty, if charged, for non-compliance with terms and conditions of a loan contract by the borrower would be treated as ‘penal charges’ and would not be levied in the form of ‘penal interest’ that is added to the rate of interest charged on the advances.
The RBI also said that there would be no capitalisation of penal charges i.e., no further interest computed on such charges.
There were other conditions laid down by the RBI. It said the amount of penal charges would be reasonable and commensurate with non-compliance with the terms and conditions of the loan contract without being discriminatory within a particular loan or product product category. It asked the banks not to introduce any additional component to the rate of interest and ensure compliance with these guidelines in both letter and spirit. The banks were directed to formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called.
The penal charges in case of loans sanctioned to ‘individual borrowers, for purposes other than business’ such as home loans, personal loans etc, would not be higher than the penal charges applicable to non-individual borrowers for similar non-compliance of terms and conditions of the loan contract, the RBI said. The quantum and reason for penal charges would be clearly disclosed by banks to the customers in the loan agreement. Further most important terms & conditions/Key Fact Statement, it directed the banks.
The RBI circular is applicable to all commercial banks, small finance banks (except payment banks), NBFCs including Housing finance companies and other financial institutions such as SIDBI, EXIM banks etc.
Why the banks want penal interest rates to continue
Banks have approached the RBI, seeking deferral of the guideline that prevents them from imposing penal interest rates on non-compliant borrowers by three months to the next financial year.
Banks have approached the Reserve Bank of India (RBI), seeking deferral of a guideline that prevents them imposing penal interest rates on non-compliant borrowers by three months to the next financial year. The RBI deadline for implementing the new guideline is January 1, 2024.
Some banks have argued that penalties should be levied only through additional interest as it leads to better credit discipline, ET has reported based on information from a source. The lenders have also sought greater clarity in respect of penal charges applicable to stressed accounts, on account of uncertainty with regard to recovery.
The banks have also sought clarity on the issue of levy of goods and services tax (GST) on penalty in case of stressed accounts. As per the existing norms, penalties levied by way of interest are not subject to GST and are considered an exempt income for banks. However, the penal charges to be levied are subject to GST.
[The Economic Times]
