What is penal interest?
Penal interest also called
Penalty interest
Penalty APR (penalty annual percentage rate)
Default interest
Interest for/on late payment
Statutory interest for/on late payment
Interest on arrears
Penal interest, in money lending and in sales contracts is punitive interest charged by a lender to a borrower if installments are not paid according to the loan terms.
If an installment is not received according to the repayment terms, sometimes if not received by the end of the month, the borrower/buyer is charged penalty interest on the delayed installment/payment.
New guidelines issued by Reserve Bank of India
The Reserve Bank of India (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.
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.
The penal charges in case of loans sanctioned to 'individual borrowers, for purposes other than business' such as home loans, personal loans etc, shall not be higher than the penal charges applicable to non-individual borrowers for similar non-compliance of terms and conditions of the loan contract.
The quantum and reason for penal charges shall be clearly disclosed by banks to the customers in the loan agreement.
Further most important terms & conditions/Key Fact Statement (KFS) as applicable, should be displayed on banks' websites under Interest rates and Service Charges.
Whenever reminders for non-compliance with the terms and conditions of the loan contract are sent to borrowers, the applicable penal charges shall be communicated.
Further, any instance of lew of penal charges and the reason therefor shall also be communicated.
Banks may cary out appropriate revisions in their policy framework and ensure implementation of the instructions in respect of all the fresh loans availed or renewed from the effective date i.e., January 1, 2024.
In the case of existing loans, the switchover to the new penal charges regime shall be ensured on the next review or renewal date or six months from the effective date of this circular, whichever is earlier.
The RBI circular is applicable to all commercial banks, small finance banks (except payment banks), NBFCs including Housing finance companies and other financial institutions such as SIDBI, EXIM banks etc.
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