In the first of two circulars issued on Friday, the Reserve Bank of India (RBI) said banks and non-banks should provide individual borrowers with the option to switch to a fixed rate at the time of resetting interest rates. Lenders should also communicate to borrowers about the possible impact of a change in the benchmark interest rate on the loan leading to changes in EMI and/or tenor or both.

Borrowers should be given a choice to pay a higher EMI or opt for a longer tenure, or a combination of both, and to prepay, either in part or in full, at any point during a loan tenure, RBI said. The rules will take effect on 31 December.

The guidelines come amid consumer grievances related to the lengthening of loan tenures and the increase in EMI on floating-rate personal loans amid rising interest rates.

“Some banks were found extending the tenure on home loans beyond 40 years at the time of rising interest rates, which meant the borrower will have to keep repaying even they are 80 years old,” a banker said.

In the last monetary policy press conference, RBI governor Shaktikanta Das also clarified that banks would have to assess the resetting of loan tenure depending on borrowers’ payment capacity and age.

“To avoid unduly long elongation, which sometimes may, going forward, camouflage underlying stress in a loan, therefore an extension of tenor should be for a reasonable period. We don’t want to define it. It’s a commercial decision of the bank,” Das said.

In a second circular, also released on Friday, RBI asked banks to stop levying penal interest but stick to penal charges where necessary.

Banks levy a penal charge when a borrower fails to adhere to covenants, while the penal interest is specified in a loan agreement.

“The intent of levying penal interest/charges is essentially to inculcate a sense of credit discipline, and such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest. However, supervisory reviews have indicated divergent practices among the REs (regulated entities) with regard to the levy of penal interest/charges leading to customer grievances and disputes,” RBI said.

According to the circular, penalty, if charged, for non-compliance with terms and conditions of a 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.

RBI said banks and non-banks should formulate a board-approved policy on penal charges or similar charges on loans. The quantum of penal charges should also be reasonable and commensurate with the non-compliance of material terms and conditions of loan contract without being discriminatory within a particular loan or product category, it said.

RBI also said penal charges in case of loans sanctioned to individual “for purposes other than business’, cannot be higher than the penal charges applicable to non-individual borrowers for similar non-compliance of contracts. These instructions will take effect in January.

“Many banks use penal interest to stop borrowers from switching loans to other banks when interest rates go up,” said a senior banker.

“The new rules could stop this practice.”

Updated: 18 Aug 2023, 10:55 PM IST