RBI Circular on Penal Charges: What Lenders Must Change in Borrower Communication
The RBI penal charges circular (DoR.MCS.REC.28/01.01.001/2023-24, dated August 18, 2023) requires lenders to treat penalties for default as "penal charges," not "penal interest." There is no capitalisation of penal charges, and the quantum and reason must be disclosed in the loan agreement, the Key Fact Statement, and every reminder to the borrower.
This is an explainer, not legal advice. For anything you plan to act on, refer to the official circular and your compliance and legal teams.
For years, lenders in India layered "penal interest" on top of the contracted rate whenever a borrower slipped. The Reserve Bank of India (RBI) decided that practice had drifted into a revenue tool and issued a circular to reset it. The change is not just accounting — it reshapes how every Regulated Entity (RE) must communicate penalties to borrowers.
What Does the RBI Penal Charges Circular Say?
The circular — RBI/2023-24/53, DoR.MCS.REC.28/01.01.001/2023-24, "Fair Lending Practice – Penal Charges in Loan Accounts," dated August 18, 2023 — applies to a wide set of REs: Commercial Banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks, excluding Payments Banks), Primary (Urban) Co-operative Banks, all NBFCs (including Housing Finance Companies), and All India Financial Institutions such as EXIM Bank, NABARD, NHB, SIDBI and NaBFID.
The RBI's stated intent: penalties are meant to inculcate credit discipline, not to enhance revenue over and above the contracted rate. The circular directs the following:
- Any penalty for non-compliance with material terms shall be treated as a penal charge and shall not be levied as penal interest added to the rate of interest.
- There shall be no capitalisation of penal charges — no further interest is computed on the charges.
- REs must have a Board-approved policy on penal charges.
- Penal charges must be reasonable and non-discriminatory within a loan or product category.
- For individual borrowers (loans for purposes other than business), penal charges cannot be higher than those applied to non-individual borrowers for similar non-compliance.
Penal Charges vs Penal Interest: What Actually Changed?
This is the heart of the circular. The two are not interchangeable.
Aspect | Penal interest (old practice) | Penal charge (required now) |
|---|---|---|
Nature | Extra percentage added to the loan's interest rate | A fixed charge for non-compliance, separate from interest |
Compounding | Could compound as it sat on the rate | No capitalisation — no interest on the charge |
Basis on default | Often on the full outstanding | Levied on the amount under default, per Board policy |
Disclosure | Frequently buried | Must be disclosed upfront in agreement, KFS/MITC, and reminders |
In short, a penalty can still be charged — but it must sit outside the interest rate, cannot snowball, and must be transparent. Lenders reviewing their broader RBI obligations may also find our guide on ensuring voice AI compliance with RBI guidelines useful.
When Did the Penal Charges Rules Take Effect?
The circular set an original effective date of January 1, 2024. The RBI subsequently extended the timeline. Per the RBI's FAQ on penal charges and a follow-up circular (DoR.MCS.REC.61/01.01.001/2023-24, dated December 29, 2023), the instructions came into effect from April 1, 2024. For existing loans, the switchover to the new regime had to be ensured on the next review or renewal date falling on or after April 1, 2024, but not later than June 30, 2024.
Note the scope limits: the instructions do not apply to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations, which are governed by product-specific directions.
What Lenders Must Change in Borrower Communication
This circular is unusual because so much of it lands on communication. Three disclosure touchpoints are named.
Loan agreement and Key Fact Statement (KFS). The quantum and reason for penal charges shall be clearly disclosed to the customer in the loan agreement and the Most Important Terms & Conditions (MITC) / Key Fact Statement (KFS), as applicable, and displayed on the RE's website under Interest Rates and Service Charges. Per the RBI's FAQ, merely referencing a schedule on the website is not compliance — the charges must be disclosed upfront in the agreement and KFS/MITC itself.
Reminders to borrowers. Whenever reminders for non-compliance are sent, the applicable penal charges shall be communicated. Any actual instance of a penal charge, and the reason for it, must also be communicated to the borrower.
No cascading. Additional penal charges cannot be levied on an earlier outstanding amount of penal charges — there is no penalty on the penalty.
For collections teams, this changes the script itself. Every reminder call, SMS, or notice must now carry a clear, correct penal-charge disclosure. Our guide on how AI ensures fair-practice compliance in collections calling walks through what that means on the ground.
How AI Helps With Penal-Charge Communication
The operational risk here is inconsistency — one agent explains the charge correctly, another forgets, and a grievance follows. AI voice agents can standardise every reminder so the applicable penal charge and its reason are stated clearly, in the borrower's language, on every contact — and logged for audit. A platform like YuVoice can carry the correct disclosure into thousands of reminder calls without drift, giving compliance teams a verifiable record that each borrower was informed. AI does not set your penal-charge policy — your Board does — but it makes sure the borrower-facing message matches that policy every single time.
FAQ
What is the difference between penal charges and penal interest? Penal interest was an extra percentage added to the loan's interest rate; penal charges are a separate, fixed penalty for non-compliance that cannot be added to the interest rate and cannot be capitalised. The RBI circular requires penalties to be levied only as penal charges.
Can penal charges be capitalised? No. The circular directs that there shall be no capitalisation of penal charges — no further interest is computed on such charges. However, normal compounding of interest on the loan itself is unaffected.
Where must penal charges be disclosed to borrowers? In the loan agreement, in the Most Important Terms & Conditions (MITC) / Key Fact Statement (KFS) as applicable, and on the lender's website. Applicable penal charges must also be communicated in reminders sent to borrowers.
When did the RBI penal charges rules become effective? The circular is dated August 18, 2023, with an original effective date of January 1, 2024. The RBI later extended applicability to April 1, 2024; existing loans switched over at the next review or renewal on or after that date, but not later than June 30, 2024.
Is there a cap on penal charges? The circular does not prescribe an upper limit, but penal charges must be reasonable and commensurate with the non-compliance and must not be used as a revenue tool. Refer to the official circular and FAQ for detail.
Do the penal charges rules apply to credit cards? No. The instructions do not apply to Credit Cards, External Commercial Borrowings, Trade Credits, and Structured Obligations, which are covered under product-specific directions.
Conclusion
The penal charges circular is a fair-lending measure with a communication core: separate the penalty from the interest rate, stop it compounding, and tell the borrower clearly and repeatedly. Lenders who rebuild their loan agreements, KFS, and reminder scripts around these rules reduce grievances and supervisory risk. For a wider view, see our complete India playbook for AI in banking collections.
Want penal-charge disclosures that are consistent and auditable? Talk to the YuVerse team to see how AI can standardise your borrower communication.
References
- Fair Lending Practice – Penal Charges in Loan Accounts (RBI/2023-24/53, August 18, 2023) — https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12527&Mode=0
- RBI FAQs — Fair Lending Practice: Penal Charges in Loan Accounts — https://www.rbi.org.in/commonman/english/scripts/FAQs.aspx?Id=3558
- Penal Charges circular (full PDF) — https://rbidocs.rbi.org.in/rdocs/notification/PDFs/FAIRLENDINGPRACTICE1B9DBE75410B4DA881E6EF953304B6F7.PDF
