Did you know there have been some recent changes in loan policies by the Reserve Bank of India (RBI)? If not, you’re in for some enlightening news!
Fresh guidelines have been rolled out aimed at ensuring fairness and transparency in the way of penal charges on loan accounts. These guidelines are effective from the 1st of April and are set to revolutionize the lending landscape, offering borrowers greater clarity and protection.
REs are directed to revise their policy framework accordingly and implement the instructions for all fresh loans availed or renewed from this date. For existing loans, on the other hand, the transition to the new penal charge regime should occur on the next review or renewal date or within six months from the effective date of the circular, whichever is earlier.
The Importance of Fair Lending Practices
Banks and financial institutions (REs) are mandated not to add any extra components to interest rates and to develop a Board-approved policy on penal charges. These charges should be reasonable, aligning with the level of non-compliance, and must not discriminate within specific loan facilities.
Moreover, penalties for individual borrowers, excluding business purposes, should mirror those for non-individual borrowers facing similar non-compliance issues. REs are required to transparently disclose the quantum and rationale behind penal charges in loan agreements, relevant documents, and on their website, specifically under the section ‘Interest Rates and Service Charges’. Additionally, reminders for non-compliance must clearly communicate the applicable penal charges.
Rest assured, these instructions are issued under relevant sections of banking and RBI regulations, and will be consistently updated in the Master Directions/Master Circulars of the respective REs. However, it’s important to note that these guidelines do not extend to specific financial products like credit cards, external commercial borrowings, trade credits, and structured obligations, which are governed by separate directives.
Key Guideline Overview
Material Terms and Conditions
These are aspects of a loan contract crucial for both the lender and the borrower. The specifics of material terms and conditions can vary depending on the credit policy of the bank and the type of loan. They could include things like interest rates, repayment schedules, collateral requirements, etc.
Applicability to Default in Repayment
Yes, the guidelines apply to default in repayment. Penal charges for such defaults must be reasonable and based on the amount under default, not the entire outstanding amount. Lenders must not capitalize penal charges, meaning they should not charge interest on these charges.
Treatment of Interest Charged During Default
Interest charged during default, including on unpaid EMIs, should not be treated as penal interest but as regular or overdue interest. Lenders can charge interest on unpaid interest at the contracted rate until the date of remediation, not at a penal rate.
Variability of Penal Charges
Penal charges can vary within the same product category depending on the amount of the loan. However, they must be reasonable and equal to the level of non-compliance. The structure of penal charges should be uniform for all borrowers within a category, regardless of their individual or non-individual status.
Levying of Fresh Penal Charges on Outstanding Amount
No, additional penal charges cannot be imposed on earlier outstanding penal charges.
Exemption of Cash Credit and Overdraft Facilities
The guidelines apply to all credit facilities unless specifically exempted. Cash credit and overdraft facilities are not exempt and are subject to penal charges rather than penal interest.
Disclosure of Penal Charges on Website vs. Loan Agreement
Displaying the schedule of penal charges on the website is not sufficient for compliance. Lenders must disclose the quantum and reasons for penal charges in the loan agreement or Key Fact Statement provided to the customer.
Upper Limit for Penal Charges
While no specific upper limit is prescribed, penal charges should be reasonable and in line with the non-compliance of loan terms. The intention is to instill credit discipline rather than enhance revenue.
Applicability of GST on Penal Charges
Instructions regarding GST are issued separately by the Central Board of Indirect Taxes & Customs. Lenders should follow instructions and clarifications provided by CBIC in this regard.
Application to Bank Guarantee and Letter of Credit
Penal charges apply to funded facilities created upon invocation of bank guarantees or devolvement of letters of credit. However, the interest charged on the devolved amount should consider associated credit risk premiums.
Treatment of Penal Charges in NPA Accounts
In the case of non-performing asset (NPA) accounts, penal charges should cease to accrue as income and should be reversed to the extent they remain uncollected, following guidelines on income recognition and asset classification.
Accounting Process for Penal Charges
Banks should credit realized penal charges under ‘Schedule 14: Other Income’ according to directions provided by the Reserve Bank of India.
Applicability to Securitization and Co-lending Portfolios
The guidelines on penal charges also apply to securitization and co-lending portfolios.
Exemption for Certain Types of Loans
The guidelines on penal charges do not apply to rupee or foreign currency export credit and other foreign currency loans.
By adhering to these guidelines, both lenders and borrowers can navigate the lending landscape with transparency and fairness, promoting responsible borrowing and lending practices.
Conclusion
Fair lending practices are the cornerstone of a healthy financial ecosystem. The recent guidelines by the RBI aim to foster fairness, transparency, and accountability in the lending landscape, benefitting borrowers and lenders alike. By adhering to these guidelines, lending institutions can build trust and confidence among borrowers while promoting financial inclusion and stability.
In conclusion, these changes mark a significant step towards ensuring a level playing field for borrowers, fostering a culture of responsible lending and borrowing in the Indian financial sector.
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