Following customer grievances regarding imposition of penalties on delayed loan payments, the RBI said it will soon issue draft guidelines on recovery of penal charges on loans.

“The supervisory reviews, which have been conducted by RBI, revealed that most banks use penal rate on top of the normal interest rates in case of payments defaults and non-compliance with the terms and conditions of sanctioning the credit facilities. The reviews indicated there were diverging practices and excessive charges in some cases, so they were leading to grievance and disputes,” said Deputy Governor M Rajeshwar Rao.

“What we are trying to do is frame guidelines, which will ensure that there will be kind of a transparent and uniform approach to this issue,” he added.

In its Statement on Developmental and Regulatory Policies, the RBI said the intent of penal interest was essentially to inculcate a sense of credit discipline among borrowers through negative incentives. However, reviews showed that regulatory entities were using this as a revenue enhancement tool over and above the contracted rate of interest.

“While the rationale for levying penalties on delinquent borrowers is to maintain credit discipline, it is frequently seen that lenders make use of this situation to augment revenue by charging steep penal interests and charges to the detriment of the borrower,” said Jaya Vaidhyanathan, CEO of BCT Digital.

According to the revised guidelines, penalty for delay/default in servicing loans or loan contracts will be in the form of ‘penal charges’ in a reasonable and transparent manner, instead of being levied as ‘penal interest’ that is added to the rate of interest being charged on the advances.

“Further, there shall be no capitalisation of penal charges (the same shall be recovered separately and shall not be added to the principal outstanding),” said the central bank, adding that however in case of deterioration in the credit risk profile of the borrower, lenders will be free to alter the credit risk premium.

Anil Gupta, Co-Group Head, Financial Sector Ratings at ICRA, said the income from these charges will typically be higher for lenders such as non-banks or banks with a higher share of self-employed segments, which could have some adverse impact on the revenues and profitability of these lenders.

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