In a major move, the Reserve Bank of India (RBI) on Friday issued draft guidelines on loan prepayment penalties, proposing to remove foreclosure charges on floating-rate loans for retail and micro, small and medium enterprises (MSME) borrowers. The loans granted for business purposes to individual borrowers will also be free of prepayment penalties.The changes will enhance the flexibility for retail and MSME borrowers to switch to another lender offering better terms and allow them to prepay their floating-rate loans without facing costly penalties. At present, retail borrowers face a penalty of 4-5% on the outstanding principal for prepaying personal loans.“
Regulated entities (REs), other than Tier 1 and 2 primary (urban) co-operative banks and base layer NBFCs, shall not levy any charges/ penalties in case of foreclosure/ prepayment of floating rate loans granted to individuals and MSE borrowers, with or without co-obligant(s), for business purpose,” an RBI’s draft circular said.Lenders frequently use prepayment penalties to discourage borrowers from shifting to another institution. Typically, these charges are intended to compensate the lender for the loss of interest income due to early repayment.In the case of MSE borrowers, these instructions shall be applicable up to the aggregate sanctioned limit of Rs 7.50 crore per borrower, said the draft.
The waiver saves MSMEs money, which they can then plough into expansion, improving cash flow or both. It ensures that small businesses are not penalised for paying off their loans early, which can be a major financial advantage.For MSME owners, this is important for two reasons: It presents an opportunity to improve their financial stability and start planning for the future, according to a report by IIFL Finance.According to the draft circular, the regulated entities should permit pre-payment of loans without stipulating any minimum lock-in period.
The RBI has invited comments and feedback from stakeholders and the public on the draft circular by March 21.“RBI’s supervisory reviews have indicated divergent practices amongst Regulated Entities with regard to levy of foreclosure charges/ pre-payment penalties in case of loans sanctioned to MSEs which lead to customer grievances and disputes,” said the RBI. “Certain REs have been found to include restrictive clauses in loan contracts/ agreements to deter borrowers from switching over to another lender, either for availing lower rates of interest or better terms of service,” it added.As per the draft norms, lenders regulated by the RBI should also not levy any charges retrospectively at the time of prepayment of loans, which were waived off by the REs or not disclosed in advance to the borrowers, under any circumstances.
