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JC - Legal Updates - Clarity Required: Not all that Clear! Penal Interest & Charges: Regime Change by RBI

Legal Updates

23 Aug 2023

Clarity Required: Not all that Clear! Penal Interest & Charges: Regime Change by RBI

Brief Overview:
 
Non-compliance with material terms and conditions on which credit facilities were sanctioned by regulated entities (“REs”): RBI instructs them to transition charging ‘penal charges. Is ‘penal interest’ then history!
 
Other instructions on the matter include formulation of board-approved policy, non-capitalization of penal charges, proper disclosures, transparency, etc.
 
Technical Details:
 
The ‘Fair Practice - Penal Charges in Loan Account’ notification has been issued by the RBI. The key instructions issued for adoption are enumerated below:
 
●  Penalty charged for non-compliance with material terms and conditions on which the credit facilities were sanctioned shall be in the form of penal charges and not levied in the form of penal interest that is added to the rate of interest (“RI”)
 
●  Penal charges shall not be capitalised.
 
●  No impact however compounding of actual interest in the loan account;
 
●  No additional components to RI;
 
●  The REs to have in place a board-approved policy on penal and other similar charges;
 
●  The quantum of penal charges is required to be reasonable and commensurate with the non-compliance.
 
●  REs are not too discriminatory within a particular loan/product category and the penal charges in case of loans to individual borrowers (“IBs”) (for purposes other than business) shall not be higher than the penal charges applicable to non-IBs for similar non-compliance.
 
●  The reminder sent for non-compliance to the borrower shall mention the penal charges and on levy of such penal charges, reasons need to be communicated.
 
Effective Date: 1st January 2024
 
For existing loans: Switch to the new regime on the next review/renewal date or six months from the effective date, whichever is earlier. 
 
Exceptions:The instructions are not applicable to credit cards, external commercial borrowings, trade credits, and structured obligations.
 
JC Key Takeaways:
 
Clear stipulations as to certain non-compliances are to attract penal charges (and not penal interest) and restrict the capitalisation of 'penal charges.
 
Still, there remain some issues that require clarity:
 
●  What would constitute ‘non-compliance of material terms and conditions?
 
●  While the notification covers only loan products, there is no mention in respect of credit facilities, that are in the form of Credit instruments like non-convertible debentures.
 
●  Currently, the interest on loans is not considered for the levy of GST, whereas the penal charges, not being interest, may elicit GST unless a specific exemption is granted.
 
●  Treatment of a payment-related default and whether capitalization of interest in relation to a payment default is permissible.
 
●  The Hon’ble Supreme Court of India has previously held that penal interest cannot be capitalized as it would be opposed to public policy. However, RBI has in this notification stated that “this will not affect the normal procedures for compounding of interest in the loan account”.
 
For further details, please see:
 
 
For any queries / clarifications, please feel free to ping us and we will be happy to chat:

●  Mr. Vedanarayanan Lakshmanan (ved.lakshmanan@jclex.com)
●  Mr. Ankit Sinha (ankit.sinha@jclex.com)
●  Ms. Rupul Jhanjee (rupul.jhanjee@jclex.com)