The Reserve Bank of India issued a draft circular on Wednesday, proposing to regulate penal charges levied on loan accounts.
The regulator said it had observed that many lenders use penal rates of interest over and above the applicable interest rates in case of defaults or noncompliance by the borrower.
"Penal interest/charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest," the RBI said. "However, supervisory reviews have indicated divergent practices amongst the regulated entities with regard to levy of penal interest/charges leading to customer grievances and disputes."
As part of its review of these charges, the central bank has proposed a set of changes in its draft circular. These include:
Interest rates on credit facilities, including conditions for reset, will be strictly governed by the relevant regulatory instructions issued in this regard.
The penalty, if charged, for the borrower's default or non-compliance with the material terms and conditions of the loan contract by the borrower shall be treated as ‘penal charges' and shall not be levied in the form of ‘penal interest' that is added to the rate of interest charged on the advances.
There shall be no capitalisation of penal charges or further interest computed on such charges.
The quantum of penal charges shall be proportional to the defaults/non-compliance with the material terms and conditions of the loan contract beyond a threshold.
Penal charges shall be clearly disclosed by the lenders to the customers in the loan agreement and the most important terms and conditions, or key fact statements.
Whenever reminders for payment of instalments are sent to borrowers, the applicable penal charges shall also be communicated.
The instructions shall not apply to credit cards, which are covered under product-specific directions.
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