RBI’s Regulation regarding interest charged by NBFC to its clients

Swetha Dhinesh

14 Jun, 2023

The Reserve Bank of India is responsible for regulating excessive interest rates charged by Non-Banking Financial Companies (NBFCs) in India, and it does so in accordance with a number of rules and regulations. The RBI is in charge of making sure that fair practices are followed and defending the interests of borrowers. The Fair Practices Code (FPC) rules, which cover laws relating to interest rates, are mandated by the RBI for NBFC adherence. The fair practices code strongly emphasizes honesty, openness, and treating borrowers fairly. It mandates that Non-Banking Financial Companies clearly and openly inform borrowers of the applicable interest rates, methodology of calculation, and other fees. In this blog, we will discuss the RBI’s regulation regarding interest charged by NBFC to its clients.

RBI’s Terms and Conditions

• By way of a sanction letter or other written document, the Non-Banking Financial Companies must inform the borrower in writing of the amount of the loan that has been approved as well as its terms and conditions, including the annualised interest rate and how it will be applied. 
• The Non-Banking Financial Companies must also keep a record of the borrower’s acceptance of these terms and conditions. In the loan agreement, NBFC must make a note of the penal interest imposed for late repayment in bold because the accusations against NBFCs normally point to the charging of high-interest or penal interest.
• It is acknowledged that occasionally, either as a result of the NBFC withholding information or the borrower lacking time to review the complete agreement, borrowers may not be fully aware of the terms and circumstances of the loans, including the rate of interest, at the time of loan sanction. 
• A fair practice that could result in disagreements between the non-banking financial companies and the borrower over the terms and conditions is failing to provide a copy of the loan agreement or any enclosures referred to in the loan agreement.
• Therefore, NBFCs are encouraged to give copies of the loan agreement to each borrower at the time of loan approval or disbursement and copies of all enclosures referred to in the loan agreement.

Regulation of excessive interest charged by Non-Banking Financial Companies

(a) The Board of an NBFC should establish an interest rate model and calculate the rate of interest to be applied to loans and advances while taking into account pertinent elements such as cost of funds, margin, and risk premium. The borrower or customer must be informed of the interest rate, the method for grading risk, and the justification for applying a varied interest rate to different groups of borrowers in the application form and the sanction letter.

(b) The interest rates and method for grading risks must also be made available on the companies’ websites or published in the appropriate newspapers. When interest rates change, the information that has been posted online or in another publication needs to be updated.

(c) To ensure that the borrower is aware of the precise rates that will be applied to the account, the interest rate should be annualised.

Complaints concerning NBFCs charging excessive interest

Numerous complaints have been made to the Reserve Bank about the levying of excessive interest and fees by NBFCs on certain loans and advances. Although the Bank does not regulate interest rates, rates above a certain point may be viewed as exorbitant and are neither sustainable nor consistent with standard financial practice. 

Therefore, the boards of NBFCs must establish proper internal policies and practices for deciding on interest rates, processing fees, and other fees. In this regard, it is important to keep in mind the requirements provided in the Fair Practises Code on disclosure of loan terms and circumstances.

What are penal charges on Loans?

Penalties are additional charges levied on a borrower. These are due when a borrower misses a payment deadline for a loan, an equated monthly instalment (EMI), or other financial obligations. The specifics of the fine assessed for a payment default vary between banks and NBFCs. In other, the penalties levied on a borrower are not governed by any set rules. Lenders typically define the conditions for missed payments regarding penalties in the contract. Borrowers have, however, reported incidents when lenders attempted to charge more than what was specified in the agreement.

RBI’s New Draft Guidelines on Fair Lending Practices

The Reserve Bank of India¹ recently released a draft circular for regulated firms to improve transparency in the disclosure of penalties and interest rates in loan accounts. The purpose of the circular is to ensure fair lending practices and prevent these regulated businesses from employing penal interest and charges to increase income above and beyond the agreed-upon interest rate.

• As concerns about non-banking financial companies are typically about charging high-interest rates or other fees, the applicable NBFCs must make the penalty for late repayment clear in the loan agreement.

• The appropriate regulatory instructions issued in this regard will strictly restrict how interest rates on credit facilities are determined, including the circumstances for interest rate resets. REs may not add any extra components to the interest rate.

•  If a penalty is assessed for the borrower’s breach of the loan agreement’s material term or condition, it will be treated as a penalty charge. It won’t be applied to the advance interest rate in the form of penal interest.

• There must be a clearly stated Board-approved policy on penalties or equivalent fees applied to loans, regardless of what they are termed.

• It is important to understand that a loan’s interest rate includes a suitable credit risk premium that reflects the borrower’s credit risk profile. If the borrower’s credit risk profile changes, REs are free to modify the credit risk premium in accordance with the terms and conditions of the contract and any prevailing directives.

• The quantum of the penalties will depend on how many material terms and conditions of the loan contract have been violated beyond a certain point. Within a certain loan or product category, this criterion must not be discriminatory and will be decided by the regulated entities.

• Penal charges cannot be capitalised so that no additional interest can be calculated on them. However, change how interest is normally compounded in the loan account.

• Additionally, the penalties for loans approved to individual borrowers for non-business purposes cannot be greater than the penalties for non-individual borrowers.

• Penalties and the prerequisites for them must be revealed to consumers by REs in the loan agreement and, if applicable, the Key Fact Statement (KFS). They must also be made public on the REs website under the heading “Interest rates and Service Charges.” The appropriate penal costs must be disclosed whenever borrowers get reminders to make instalments.

• During the RBI’s supervisory investigation, the operationalisation of “penal charges” in substitution of “penal interest” will be appropriately reviewed.

Conclusion

Borrowers must be aware of their rights and the laws controlling the interest rates NBFCs may charge. Borrowers may file a complaint with the NBFC and, if required, take their case to the RBI if they feel they have been subjected to excessive interest rates. The RBI treats these complaints seriously and responds to all regulatory violations by taking the required measures. 

Read our Article:Safe custody of liquid assets and collection of interest by NBFC on SLR securities

1. https://www.rbi.org.in/