RBI rules replace penal interest with flat penal charges from April 2024 — no compounding, no capitalisation, full disclosure mandatory for FY 2026-27.
The Reserve Bank of India's Fair Lending Practices — Penal Charges in Loan Accounts circular, in force since 1 April 2024 and reinforced in 2026 supervisory action, has fundamentally reshaped how banks, NBFCs and HFCs levy charges on borrowers who default or breach covenants. For FY 2026-27, lenders cannot disguise revenue as penalty, capitalise penal charges or compound them — a relief for retail and MSME borrowers alike.
From Penal Interest to Penal Charges
The earlier industry practice was to load 2% to 5% per annum of penal interest on top of the contractual rate, often compounded monthly. RBI now treats this as a non-compliant revenue tool. Lenders must convert penal interest into a flat, reasonable penal charge — disclosed upfront in the sanction letter, the Key Fact Statement and every reminder notice. The charge cannot accumulate to the principal or attract further interest.
Key Principles in the RBI Framework
- Penal charges must be proportionate to the default and not used as a revenue stream.
- Quantum of charges must be reasonable, board-approved and non-discriminatory.
- No differential pricing for retail versus corporate borrowers without justification.
- Charges must be communicated in writing each time they are levied.
- No compounding of penal charges or capitalisation into the loan outstanding.
What This Means for Borrowers
If you delay an EMI on a home loan, personal loan or MSME credit facility in FY 2026-27, you will pay a one-time penal charge instead of an escalating penal interest. The charge is GST-exempt for genuine loan defaults but may attract GST if the underlying transaction is service-based. Borrowers should ask their lender for a revised KFS and ensure penal charges in past statements have been reversed where the lender did not migrate by the deadline.
Disclosure and Grievance Redressal
Every regulated entity must publish its penal charge schedule on its website and link it to the loan agreement. Borrowers who find compounding or unjustified charges can escalate to the Internal Ombudsman and then to the RBI Integrated Ombudsman Scheme 2021. Recovery of unjust charges has become a frequent ombudsman outcome since the rule took effect.
Implications for Lenders
Lenders had to overhaul their loan management systems, change KFS templates, retrain collection teams and reverse non-compliant accruals. Boards must annually review the penal charge policy. Non-compliance has been flagged in RBI inspection reports and triggered monetary penalties on multiple co-operative banks and NBFCs in 2025.
Conclusion
The penal charges framework rebalances the lender-borrower equation by ending revenue dressed as discipline. Borrowers should scrutinise statements, request reversals where applicable, and lenders must build transparency into every default communication.
