On default, lenders may levy a flat 'penal charge' but not 'penal interest' — and cannot compound it or treat it as a profit line. (RBI/2023-24/53, dated August 18, 2023.) It applies to all commercial banks (incl. sfbs, labs, rrbs; excl. payments banks). Effective: From January 1, 2024 (existing loans: by next review/renewal or within 6 months, whichever is earlier).
RBI found that many lenders were using penal interest as a revenue tool rather than a discipline tool. This circular draws a clean line. Any penalty for breaching the material terms of a loan must be a 'penal charge' — a flat amount — and must not be levied as 'penal interest' bolted onto the loan's interest rate. Crucially, penal charges cannot be capitalised: no further interest is computed on the penalty. Normal compounding of the regular interest in the account continues as usual.
Lenders cannot add any new component to the rate of interest to sidestep this. Each RE must adopt a Board-approved policy on penal charges. The amount must be reasonable and proportionate to the breach, and non-discriminatory within a given loan or product category. There is an important consumer protection: for loans to individual borrowers for non-business purposes, penal charges cannot exceed those applied to non-individual borrowers for the same breach.
Transparency is mandatory. The quantum and reason for penal charges must be spelled out in the loan agreement, in the most important terms & conditions / KFS, and displayed on the lender's website under interest rates and service charges. Whenever a reminder for non-compliance is sent, the applicable penal charge must be communicated, as must any actual levy and its reason.
For a LAP or home-loan book, this means EMI-bounce and covenant-breach penalties must be re-papered as charges, removed from the interest computation, and disclosed up front. Credit cards, ECBs, trade credits and structured obligations are outside this circular — they follow their own product directions.
Penal interest is an extra rate added to your loan's interest. A penal charge is a flat fee. RBI now allows only the flat charge, and it cannot be compounded.
Yes. Normal compounding of the contracted interest continues. Only the penalty itself cannot attract further interest.
Yes. LAP, home loans and other advances are covered. Only credit cards, ECBs, trade credits and structured obligations are excluded.
No fixed number, but it must be reasonable, proportionate to the breach, and non-discriminatory. Individual non-business borrowers cannot be charged more than non-individuals for the same breach.
By the next review or renewal date, or within six months of 1 January 2024, whichever is earlier.