On August 18, 2023, the Reserve Bank of India (RBI) issued the instructions es/circulars in relation to Fair Lending Practice - Penal Charges in Loan Accounts (ref no. RBI/2023-24/53); ("Penal Charges Instruction"); Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans (ref no. RBI/2023-24/55) ("Interest Reset Circular "); and Review of Regulatory Framework for IDF[1]NBFCs (ref no. RBI/2023-24/54) ("IDF Review Circular "). In a snapshot-

  • Penal Charges Instruction intends to streamline the charging of default/ penal interest and has clarified that such charges are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest.
  • The Interest Reset Circular seeks to address consumer grievances arising from the potential elongation of loan tenor and increased EMIs during periods of rising interest rates by enhancing transparency, communication, and borrower empowerment in the context of EMI-based floating rate personal loans. The said regulation outlines specific guidelines to be adhered to by regulated entities ("REs"), by emphasizing on prudent lending practices and effective communication with borrowers.
  • With the intent to enhance the role of the Infrastructure Debt Fund – Non-Banking Finance Company ("IDF-NBFC") in financing the infrastructure sector, RBI has revised the existing framework governing the IDF-NBFCs by way of issuance of IDF Review Circular wherein, RBI has inter alia opened new avenues for fundraising, eliminated the requirement of sponsorship of the IDF[1]NBFCs by the NBFC-IF

Key takeaways:

1. Penal Charges Guidelines:

  1. The Penal Charges Instruction has amended: (a) Master Direction – Reserve Bank of India (Interest Rate on Advances) Directions, 2016; (b) Master Direction – Non-Banking Financial Company – Non-Systemically Important Non-Deposit taking Company (Reserve Bank) Directions, 2016; (c) Master Direction - Non-Banking Financial Company -Systemically Important Non-Deposit taking Company and Deposit taking Company (Reserve Bank) Directions, 2016; (d) Master Direction - Non-Banking Financial Company – Housing Finance Company (Reserve Bank) Directions, 2021; (e) Master Circular- Management of Advances – UCBs dated July 25, 2015; (f) Master Circular - Customer Service in Banks July 1, 2015; and (g) Master Circular - Loans and Advances - Statutory and Other Restrictions dated July 1, 2015;
  2. Applicability: To all commercial banks, NBFCs, all financial institutions and all primary urban co-operative banks;
  3. Penal interest charges: Any amount charged for non-compliance with loan contract terms will be treated as 'penal charges' (rather than the 'penal interest'). Therefore, (a) no additional interest over and above the agreed applicable interest rate can be charged; and (b) there can be no capitalisation of penal charges i.e., no further interest can be computed on the penal charges. Applicable penal charges are required to be communicated to borrowers in reminders for non-compliance. In case of levy of such charges, the reason for such levy also needs to be communicated. Accordingly, going forward the REs will need to specify the penal charges which will be charged upon occurrence of the event of default under the financing agreements;
  4. No new interest component: REs cannot introduce any new components to the applicable interest rate;
  5. Board-approved policy: REs shall formulate a board-approved policy for penal charges;
  6. Reasonable and uniform penal charges: Penal charges must be reasonable and proportional to the level of non-compliance, without discrimination within specific loan/ product categories or even borrowers;
  7. Individual borrower loan: Penal charges on individual borrowers (non-business purposes) shall not exceed those for non-individual borrowers facing similar non[1]compliance;
  8. Disclosure of penal charges and rationale: REs must clearly disclose the amount and rationale for penal charges in loan agreements, key terms & conditions, on their website under the head of interest rate and service charges; and
  9. Effective date of the instructions: January 1, 2024. With respect to the existing loans, the REs are required to transition to the new penal charges regime during the next review, renewal, or within six months from January 1, 2024, whichever comes earlier.

2. Interest Reset Circular:

  1. Communication and impact assessment: At the time of loan sanction, REs are mandated to provide borrowers with clear and comprehensive communication regarding the potential impact on EMIs and tenor as a result of changes in the benchmark interest rates. In the event of any subsequent increase in the EMI or tenor due to changes in external benchmark rates, REs are required to promptly communicate such adjustments to the borrowers through appropriate channels. Proactive communication strategy is to ensure that borrowers are well-informed and prepared for any changes in their loan terms;
  2. Flexibility and borrower choice: The regulation stresses the importance of borrower choice and flexibility. REs are directed to offer borrowers the option to switch from a floating to a fixed interest rate at the time of interest rate reset. This provision is subject to the RE's board-approved policy. Additionally, borrowers are empowered to make decisions regarding EMI enhancement, tenor elongation, or a combination of both, along with the option to prepay, either partially or in full, at any point during the loan tenor. Any charges related to switching and prepayment must be fully disclosed and transparently communicated to borrowers;
  3. Prevention of negative amortization: To ensure responsible lending practices, the aforesaid RBI notification explicitly requires that any elongation of the loan tenor for floating rate loans must not result in negative amortization. This provision is to safeguards borrowers from entering into unfavourable loan conditions and maintains the integrity of the lending process;
  4. Quarterly statements and transparency: To enhance borrower understanding and transparency, REs are now mandated to share, through appropriate channels, quarterly statements that comprehensively detail the principal and interest recovered, EMI amount, number of remaining EMIs, and the annualized rate of interest or annual percentage rate for the loan's entire tenor. These statements are required to be simple and easily comprehensible, fostering borrower confidence and informed decision[1]making;
  5. Application and compliance: The guidelines delineated in this circular are applicable not only to equated instalment loans but extend, mutatis mutandis, to all equated instalment-based loans of varying periodicities. Also, the existing borrowers are required to be informed of the available options via appropriate communication channels; and
  6. Implementation: REs are required to implement these guidelines for both existing and new loans by December 31, 2023.

3. IDF Review Circular:

  1. Change in the Definition of IDF-NBFC: The IDF Review Circular by redefining an IDF[1]NBFC has now allowed NBFC-IDFC to refinance all the infrastructure project (not just PPP) and finance toll operate transfer project as direct lender. Further an IDF-NBFCs can opt out of being a party to the tripartite agreement with the concessionaire and the project authority;
  2. New Fund Avenues – External Commercial Borrowing: The earlier regime, allowed IDF-NBFCs to raise the funds only by way of issuance of Rupee or Dollar denominated bonds of minimum 5 (five) year maturity and through shorter tenor bonds and commercial papers (CPs) from the domestic market to the extent of up to 10% (ten percent) of their total outstanding borrowings. The IDF Review Circular, now permits IDF-NBFCs to also raise funds in the form of external commercial borrowings (ECBs) subject to minimum tenor of five years. Such ECBs should however, not be sourced from foreign branches of Indian banks. For the ECB loans, IDF-NBFCs are also required to adhere to the guidelines issued in relation to ECBs and by the Foreign Exchange Department of the RBI;
  3. Requirements of a sponsor: The requirement that the sponsor of an IDF-NBFC has to be an NBFC-Infrastructure Finance Company (NBFC-IFC) has now been withdrawn and now shareholders of IDF-NBFCs are subjected to scrutiny in the same manner as any other NBFC including NBFC-IFCs;
  4. NBFC-ICCs Regulations: Now all the regulatory norms including income recognition, asset classification, and provisioning norms as applicable to Non-Banking Financial Company-Investment and Credit Companies, shall be applicable to IDF-NBFCs;
  5. Revised capital-to-risk weighted assets ratio (CRAR): In addition to the existing 15% (fifteen percent) CRAR requirement, IDF NBFCs are now also required to ensure that the CRAR shall also contain a minimum Tier 1 capital of 10% (Ten percent); and
  6. Simplified Exposure limits: The exposure limits for IDF-NBFCs have been changed to be 30% (thirty percent) of their Tier 1 capital for a single borrower/ party and 50% (fifty percent) of their Tier 1 capital for a single group of borrowers/ parties.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.