RBI circular:  ‘Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans’

RBI circular:  ‘Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans’

Subject: Economy

Section: Monetary Policy

RBI’s Guidelines on Interest Rate Reset:

• Lenders must provide borrowers with clear information about how changes in the benchmark interest rate can affect personal loans.
• Communicate potential changes in EMI and/or tenor during the loan sanction process.
• REs to ensure that the instructions contained in the circular are extended to existing as well as new loans, suitably by December 31, 2023
• Direct borrowers towards making informed decisions.

Option to Switch to Fixed Rate:

• Borrowers can choose to switch to a fixed interest rate during the interest rate reset period.
• The policy should define the frequency and conditions for switching during the loan term.
• Banks can limit the number of switches to maintain financial stability.
• Prevents borrowers from exploiting rate changes for personal gain.

Borrowers have the choice to:

• Opt for a higher EMI or longer tenor.
• Prepay a part or the entirety of the loan during its term.
• Provides flexibility based on individual financial situations.
• Prevents overburdening borrowers with rigid terms.

Charges and Transparency:

• Charges for switching and services must be fully disclosed.
• Foreclosure charges or pre-payment penalties will be subject to extant instructions
• Transparent communication about charges during revisions.

Quarterly Statement and Reporting

Quarterly Statements:

• Lenders are required to share a statement with borrowers at the end of each quarter.
• The statement should include:
  • Principal and interest recovered to date.
  • Remaining EMIs.
  • EMI amount.
  • Annualized interest rate.
• Enables borrowers to track their loan progress.
• Statements must be easily comprehensible.

Broad Applicability:

• Not limited to personal loans only.
• Applies to all equated installment-based loans with varying periodicities.

Personal Loan Definition

• Personal loans encompass various categories:
  • Consumer credit.
  • Education loans.
  • Loans for immovable assets.
  • Loans for financial assets.
• Outstanding personal loan amount: Rs 42.60 lakh crore as of June 2023.

RBI’s Directive on Penal Interest

• RBI directs lenders not to charge penal interest for non-compliance, benefiting consumers.
• Norms are introduced due to observed excessive penal rates by regulated entities (RE).
• Penal charges are defined as additional fees for late EMI payments, defaults, and non-compliance.
• No capitalization of penal charges; regular compounding for interest applies.
• New guidelines apply to banks, excluding payments banks, NBFCs, housing finance, and co-operative banks.
• Lenders are prohibited from adding new interest rate components; must follow board-approved policy.

Consumer Impact and Transparency

• Individual borrower penalties for non-compliance aligned with non-individuals.
• REs must transparently disclose penalty amounts and reasons in agreements, KFS (Key Fact Statement), and websites.
• Communication of penalties with non-compliance reminders; reasons communicated.
• New instructions effective from January 1, 2024; existing loans transition within 6 months or the next review (whichever is earlier).

Exemptions

• Instructions are not applicable to credit cards, external borrowings, trade credits, or structured obligations.