No more penal interest: How RBI decision will help home, personal, car and other loan borrowers
February 8, 2023
In a move that will help customers, the Reserve Bank of India (RBI) has proposed to do away with the levy of “penal interest” on loan defaults by regulated entities and replace it with “penal charges”. The central bank will issue draft guidelines on the issue for comments from stakeholders soon.
In the bi-monthly ’Statement on Developmental and Regulatory Policies’ released today (February 8), the RBI said that “divergent practices” by regulated entities with regard to the levy of penal interest have led to customer grievances and disputes have been seen.
“The intent of penal interest was essentially to inculcate a sense of credit discipline among borrowers through negative incentives but such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest,” the RBI said.
“Supervisory reviews have indicated divergent practices amongst REs with regard to levy of penal interest which were excessive in certain cases, leading to customer grievances and disputes,” it added.
In view of the above, the central bank has decided to replace “penal interest” with “penal charges”.
“It has been decided that any penalty for delay/default in servicing of the loan or any other non-compliance of material terms and conditions of loan contract by the borrower shall be in the form of ‘penal charges’ in a reasonable and transparent manner and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest being charged on the advances,” the central bank said.
How will RBI decision help borrowers
Banking and legal experts are of the view that the RBI’s proposal will immensely help loan customers.
“Draft guidelines on Recovery of Penal Charges on Loans by regulated entities could initiate uniform processes across the players so that the process is transparent and could benefit the customers,” said A K Goel, Chairman of Indian Banks’ Association (IBA).
According to Supreme Court Advocate Tushar Agarwal, many recovery cases are pending in courts and tribunals at the behest of banks where the borrowers have challenged the levy of excessive penal interest by bank on loans availed by them. This itself reflects the prevailing complexity of rules and regulations in this field.
“In this scenario, the RBI Governor’s statement about the issuance of draft guidelines on the levy of penal charges, will not only enhance the credibility of the banks but will also strengthen the trust of borrowers. Disbursal of easy loans is a lifeline for any business, therefore penal charges have to be levied keeping in mind the mutual interest of both the lender and borrower because in some genuine cases, the default by a borrower in repayment of the loan is not intentional rather it is compelling due to business loss or financial crunch,” said Agarwal.
Karan Ajitsaria, Partner at DSK Legal, also says that the RBI’s decision may lower the burden of borrowers. However, proposed guidelines should also clarify the extent of penal charges that may be levied.
“The proposal of the Reserve Bank of India to levy penal charges and do away with ‘penal interest’ on loan defaults seems to be in the interest of the borrowers. It is proposed that the penal charges will not be added on to the principal amount and the same will be recovered separately from the borrowers. This should reduce the burden on the borrowers. However, the proposed guidelines will have to clarify the extent of penal charges that may be levied (including the circumstances under which they can be levied) by the regulated entities, such that the borrowers are conscious not to default under their loan documents and the penal charges continue to be a deterrent for the borrowers to not default,” said Ajitsaria.
Move to bring credit discipline
“The move suggested by the Reserve Bank of India, towards the recovery of penal charges, is with an intent to harmonize the divergent practices around charging of penal interest rates across the industry, with an intent to meet the spirit of charging penal interest – which is to bring credit discipline. This is a positive move by the RBI towards market conduct and is in line with the increased focus of global regulators towards conduct risk,” said Vivek Iyer, Partner and leader, Financial services risk at Grant Thornton Bharat.
[The Financial Express]
