Banks can’t add penal charges on loans to interest rate, no compound interest on these: RBI

economictimes.indiatimes.com:

RBI) has issued a circular on how banks can levy penalties on loan accounts. The new guidelines have come after it has been observed that many banks use penal rate of interest, over and above the applicable interest rates, in case of defaults / non-compliance by the borrower with the terms on which credit facilities were sanctioned. The new guidelines will come into effect from January 1, 2024.

As per the circular issued, 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. There shall be no capitalisation of penal charges i.e., no further interest computed on such charges. However, this will not affect the normal procedures for compounding interest in the loan account.

The RBI has asked the banks not to introduce any additional component to the rate of interest and ensure compliance with these guidelines in both letter and spirit. The banks shall formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called. The amount of penal charges shall be reasonable and commensurate with non-compliance with the terms and conditions of the loan contract without being discriminatory within a particular loan or product category.