Rbi’s Guidelines On Transparent Interest Practices

Posted On - 9 May, 2024 • By - King Stubb & Kasiva

Rbi’s Guidelines On Transparent Interest Practices

In the realm of financial services, fairness and transparency are fundamental principles. The Reserve Bank of India (RBI) has consistently upheld these principles, and on April 29, 2024[1], it issued a directive aimed at ensuring transparency in the charging of interest by lenders.

Key Points:

Unethical Practices: During its on-site examination of Regulated Entities (REs), the RBI identified instances of lenders engaging in unfair practices regarding the interest charges. These included:

  • Charging interest from the date of loan sanction or execution of the loan agreement, rather than from the date of actual disbursement.
  • Charging interest for the entire month, regardless of the actual tenure for which the loan was outstanding.
  • Collecting advanced installments without adjusting the interest calculation accordingly.

These practices, while not illegal, were deemed unfair and not in alignment with the principles of fairness and transparency.

Immediate Action Required: In response to these findings, the RBI issued a directive mandating all REs to review their practices regarding the mode of disbursal of loans, application of interest, and other charges. Corrective actions, including essential system-level changes, are necessary to address the highlighted issues.

Refunds and Encouragement: The RBI emphasized the importance of refunding excess interest and other charges to customers impacted by such practices. Additionally, they encouraged REs to adopt online account transfers as a more efficient and transparent alternative to traditional cheque disbursement methods.

Effective Implementation: The circular, which took immediate effect on April 29, 2024, applies to all commercial banks, co-operative banks, and non-banking financial companies, excluding payments banks.

Overview:

Observed PracticeRegulatory Directive
Charging interest from loan execution or sanction date (no disbursement yet)Interest commences only from the actual disbursement date
Charging interest based on a specific date, ignoring the delay between the cheque issuance and its receipt by the borrowerInterest aligns with the date the cheque is handed over
Receiving advance EMIs but computing interest on the total loan amount (without adjusting for the advance payment)Interest calculation considers netting off the advance EMI from the disbursed amount

Conclusion:

The RBI’s “Fair Practices Code for Lenders – Charging of Interest” marks a significant step towards promoting fairness and transparency in the lending ecosystem. By addressing and rectifying these practices, lenders can build trust and credibility with their customers, ultimately strengthening the integrity of the financial sector as a whole.

As we move forward, it is imperative for all stakeholders to wholeheartedly embrace these guidelines and work together to create a lending environment characterized by fairness, transparency, and trust.

[1] https://rbi.org.in/Scripts/NotificationUser.aspx?Id=12678&Mode=0#:~:text=Fair%20Practices%20Code%20for%20Lenders%20%E2%80%93%20Charging%20of%20Interest&text=The%20guidelines%20on%20Fair%20Practices,regards%20their%20loan%20pricing%20policy.