The Reserve Bank of India (RBI) has rebuked banks for overcharging borrowers under the pretence of penal interest rates and has proposed measures to shield borrowers from unfair charges. The regulator stated in a drafted circular on levying penal charges on loan accounts that the penalty should be levied as a charge rather than as a compounding interest rate.
RBI released these draft norms on Wednesday and asked the relevant stakeholders to submit their comments by May 15.
While the banking regulation has granted banks operational liberty to charge borrowers penalties, it has come to light that this is being exploited as a “revenue enhancement tool”.
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Penal interest is not intended to be used as a revenue-boosting tool above and beyond the contracted rate of interest. However, supervisory assessments have revealed disparities in the charging of penal interest among regulated firms, resulting in client complaints and conflicts. The regulator has now proposed that the determination of interest rates on credit facilities, including interest rate reset conditions, be rigorously restricted by the relevant regulatory instructions issued.
It has also stated that the penalty will not be imposed as ‘penal interest’, which is added to the interest rate charged on the advances.
“It must be recognised that the interest rate on a loan includes an appropriate credit risk premium that reflects the borrower’s credit risk profile. The REs are permitted to adjust the credit risk premium in accordance with the provisions of the contract if the borrower’s credit risk profile changes”, it stated.
The regulator stated in its February monetary policy that it intends to cap the penalties incurred by banks and nonbanks for late loan payments, providing assistance to borrowers.