Recent draft circular of RBI on Penalty Fee A welcome move on loan accounts that should bring relief to individual borrowers. The RBI has emphasized that it seeks to ensure that lenders do not seek undue advantage from borrowers’ default in repayment of their loans, even if it leads to a change in the ‘credit risk profile’ of the borrower to the loan provider. Allows revaluation of loan, if any. Central Bank’s Draft Guidelines on ‘Fair Lending Practices’ These are aimed at ending a practice where lenders have so far charged penal interest in excess of the contracted rate of interest for delay or default in repayment by borrowers. Noting that the regulatory objective of the penal levy was solely to promote credit discipline among borrowers by way of a negative incentive, the RBI said that lenders had in practice converted the penal interest into a revenue enhancement tool. Supervisory reviews had found that some institutions were actually charging ‘exorbitant’ rates of penal interest, causing hardship to borrowers and disputes. Lenders also capitalized the penal interest, in some cases, thereby increasing the principal amount that the borrower would eventually have to repay. The banking regulator has now insisted that the penal charge should be charged separately and should not be added to either the principal outstanding amount or the rate of interest charged on the loan. However, the lenders may still follow the normal procedure for compounding the outstanding principal interest, it clarified.
RBI’s decision to take steps to ensure a fair and transparent approach to credit pricing should be viewed in the context of the sharp increase in retail lending in recent years. While the share of industry in outstanding bank loans has come down to about 24% by February 2023, from 43% in 2014-15, the all-encompassing category of personal loans has grown to 30% from just 19% eight years ago, making it The country’s largest bank loan became. Largest credit category. The central bank has made it clear to lenders that while it gives them the freedom to determine the quantum of penalty fee in proportion to default or non-compliance with the terms of the loan contract beyond pre-determined limits, there should be no discrimination within the limits. A specified loan or product category. And the penalty fee charged to individual borrowers cannot be at a higher rate than the same fee charged to corporate borrowers. Importantly, repeat penal charges should be communicated to the borrower at the time of finalization of each loan and in each subsequent reminder for loan repayment. Small borrowers will surely heave a sigh of relief as RBI has made it clear that it will not tolerate usury of any kind.