Reserve Bank has issued various guidelines to the Regulated Entities (REs) to ensure
reasonableness and transparency in disclosure of penal interest. Under the extant
guidelines, lending institutions have the operational autonomy to formulate Board
approved policy for levy of penal rates of interest. It has been observed that many REs
use penal rates of interest, over and above the applicable interest rates, in case of
defaults / non-compliance by the borrower with the terms on which credit facilities were
sanctioned.
2. The intent of levying penal interest/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. However, supervisory reviews have
indicated divergent practices amongst the REs with regard to levy of penal
interest/charges leading to customer grievances and disputes.
3. On a review of the practices followed by REs for charging penal interest/charges on
loans, the following instructions are issued for adoption.
(i) Penalty, if charged, for non-compliance of material terms and conditions of loan
contract by the borrower shall be treated as ‘penal charges’ and shall not be levied in the
form of ‘penal interest’ that is added to the rate of interest charged on the advances.
There shall be no capitalisation of penal charges i.e., no further interest computed on
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such charges. However, this will not affect the normal procedures for compounding of
interest in the loan account.
(ii) The REs shall not introduce any additional component to the rate of interest and
ensure compliance to these guidelines in both letter and spirit.
(iii) The REs shall formulate a Board approved policy on penal charges or similar charges
on loans, by whatever name called.
(iv) The quantum of penal charges shall be reasonable and commensurate with the noncompliance
of material terms and conditions of loan contract without being discriminatory
within a particular loan / product category.
(v) The penal charges in case of loans sanctioned to ‘individual borrowers, for purposes
other than business’, shall not be higher than the penal charges applicable to nonindividual
borrowers for similar non-compliance of material terms and conditions.
(vi) The quantum and reason for penal charges shall be clearly disclosed by REs to the
customers in the loan agreement and most important terms & conditions / Key Fact
Statement (KFS) as applicable, in addition to being displayed on REs website under
Interest rates and Service Charges.
(vii) Whenever reminders for non-compliance of material terms and conditions of loan are
sent to borrowers, the applicable penal charges shall be communicated. Further, any
instance of levy of penal charges and the reason therefor shall also be communicated.
(viii) These instructions shall come into effect from January 1, 2024. REs may carry out
appropriate revisions in their policy framework and ensure implementation of the
instructions in respect of all the fresh loans availed/ renewed from the effective date. In
the case of existing loans, the switchover to new penal charges regime shall be ensured
on next review or renewal date or six months from the effective date of this circular,
whichever is earlier.
4. The above instructions are issued under sections 21, 35A and 56 of the Banking
Regulation Act, 1949, sections 45JA, 45L and 45M of the Reserve Bank of India Act,
1934, and section 30A of the National Housing Bank Act, 1987 and shall be updated in
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the relevant Master Directions / Master Circulars of the applicable REs. The list of
amendments to the Master Directions / Master Circulars has been provided in the Annex.
5. These instructions shall, however, not apply to Credit Cards, External Commercial
Borrowings, Trade Credits and Structured Obligations which are covered under product
specific directions. please provide the audit checkpoints for internal audit purpose in 50 words