RBI’s regulation of interest rates and penal charges: Next financial regulatory hot topic in India? [Part I]

Reserve Bank of India (RBI) Governor Shaktikanta Das, in his first monetary policy statement of 2023 highlighted the need for rationalisation of the levy of penal interest by Regulated Entities (REs). He added that some REs has been found to be charging excessive fees. The Governor stated,

“At present, Regulated Entities (REs) are required to have a policy for levy of penal interest on advances. The REs follows divergent practices in levying such charges. In certain cases, these charges are founded to be excessive. To further enhance transparency, reasonableness and consumer protection, draft guidelines on levy of penal charges will be issued to obtain comments from stakeholders.”

The issue of penal charges and interests came to RBI’s attention through various complaints that were filed before the Ombudsman by borrowers. For the last three years or so, RBI has been reprimanding banks and NBFCs through the office of the Ombudsman over the issue of interest rates and other fees charged. Over the years, however, this was found to be inadequate and a need for guidelines was felt.

According to the RBI Master Circular on Interest Rates on Advances, banks have the autonomy to formulate a transparent policy for penal interest, approved by their Board of Directors. However, for loans under the priority sector, no penal interest should be charged for loans up to Rs. 25,000. Deputy Governor of RBI, Shri M Rajeshwar Rao, has noted that recent supervisory reviews by the central bank have shown that most banks impose a penal interest rate on top of the regular interest rate in the case of payment defaults and non-compliance with loan terms and conditions. This led to concerns about exorbitant penal interest rates being charged by lenders.

Up until recently, interest rates were regulated only for banks and microfinance institutions. Non-Banking Finance Companies (NBFCs) for example, were outside the purview of interest rate thresholds. This may be about to change since the Governor has now indicated changes on cards for all regulated entities which include NBFCs. Now, RBI is on a drive to rationalize interest rates for all Regulated Entities.

It is key to note that Regulated Entities includes all Commercial Banks (incl. Small Finance Banks, Local Area Banks, and Regional Rural Banks) excluding Payments Banks; all NBFCs (including Microfinance Institutions and Housing Finance Companies); and all Primary (Urban) Co-operative Banks/ State Co-operative Banks/ District Central Co-operative Banks.

Prepayment charges refer to the fees imposed by lenders for the premature repayment of debt. These charges are meant to compensate for the potential loss that the lender may incur as a result of such early repayment. However, RBI has put restrictions on the imposition of such charges for certain categories of loans. As per RBI's circular, scheduled commercial banks, small finance banks, and local area banks are prohibited from charging prepayment penalties to individual borrowers on home loans and floating rate term loans. However, non-individual borrowers, such as businesses, may still be subject to prepayment charges.

The Ministry of Electronics and Information Technology (MeitY) in India has banned and issued a show cause notice to multiple loan applications operating in the country. MeitY has received a blocking request under Section 69A of the Information Technology (IT) Act 2000, from the Ministry of Home Affairs for blocking banks and NBFCs pertaining to digital lending applications and against recovery agents or harassment by recovery agents of such lending platforms. The move comes in response to allegations of misconduct and unethical practices, including unauthorised access to users' sensitive data and misuse of such information. Such online loan applications have been accused of indulging in illegal money lending practices and charging exorbitant interest rates. This significant development is also a reminder of the regulatory oversight that exists in the digital space.

Some companies that have been recently banned include some big names such as PayU, LazyPay, Kissht, KreditBee and Indiabulls’ Home Loans.

MeitY has issued these show cause notices under Section 69A of IT Act 2000. Section 69A of the IT Act 2000 in India provides power to the central government or any of its officers specially authorized by it to direct any agency of the government to block or restrict access to any information through any computer resource if it deems it necessary or expedient.

The provisions of Section 69A of the IT Act have been highly controversial and have faced criticism for potentially being used to censor legitimate speech and for being opaque in its operations. The provision requires that the decision to block or restrict information be guided by principles of necessity and proportionality and that any such order be reviewed within a period of two months.

Part II of this article shall be covering the causes behind such show-cause notices to the loan applications, annualised interest rate computation and the way forward in the regulatory space regarding penal charges or penal interests.

Anuroop Omkar and Kritika Krishnamurthy are Partners at AK & Partners.