The Reserve Bank of India (RBI) has introduced significant measures to alleviate the concerns of borrowers. Firstly, the RBI has urged banks to offer a fixed interest rate option to individual borrowers and has directed lenders to impose reasonable penalty charges for defaulting on EMI payments. This move is anticipated to provide relief to borrowers amidst the backdrop of escalating interest rates, especially as most retail loans are currently tied to floating rates.
At present, many Regulated Entities (REs) employ penal rates of interest on top of applicable rates when borrowers default or fail to comply with credit facility terms. The intention behind such charges is to instill credit discipline, not to generate extra revenue. However, varying practices among REs have led to customer grievances and disputes. The RBI clarified that penalties for non-compliance with loan contract terms will be considered as ‘penal charges’ rather than ‘penal interest.’ Furthermore, penal charges should not be capitalized upon, ensuring no additional interest is calculated on them. The RBI emphasized that the magnitude of penal charges should be reasonable and proportional to the extent of non-compliance.
These directives, outlined in the ‘Fair Lending Practice – Penal Charges in Loan Accounts,’ will be effective starting January 1, 2024.
Additionally, the RBI’s second directive focuses on EMI-based floating rate personal loans. The RBI highlighted that consumer complaints have arisen due to elongation of loan tenures or increased EMI amounts for such loans without proper communication or consent from borrowers. The RBI directed banks and NBFCs, including housing finance companies, to provide borrowers the option to switch to a fixed rate during interest rate resets. The institutions’ policies should define the number of allowable interest rate switches during the loan tenure.
At the loan sanction stage, lenders must transparently communicate the potential impact of benchmark interest rate changes on EMIs and tenures. Any subsequent increase in EMIs or tenures due to such changes must also be promptly conveyed to borrowers. The RBI has mandated that both existing and new loans comply with these instructions by December 31, 2023.
Rising interest rates, implemented since May of the previous year, have led to a 250 basis points increase in the repo rate by the central bank to combat inflation. This has resulted in negative amortization for numerous borrowers, where EMIs fall below interest obligations, causing a persistent rise in the principal amount.
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