RBI against loan prepayment penalty

The Reserve Bank of India has frowned on the practice of banks slapping penalty charges on premature repayment of loans, saying it does not approve of such charges. But it stepped back from any role in enforcing its point of view.

Replying to an RTI query, the central bank said, “RBI does not approve of charging penalty or foreclosure charges. We have... advised banks to lay out appropriate internal principles and procedures so that usurious interest including processing and other charges are not levied by them on loans and advances.”

The RBI admitted it had received complaints on levy of prepayment penalty by banks who had been “suitably advised”. But it was silent on what action had been taken against banks who ignored the advice. The charges disadvantage those wanting to pay off a loan or move to one offering better terms.

Early Bird Fine Foreclosure:

Usually refers to a lender seizing a property when borrower is unable to repay loan. But in India, the term also refers to prepayment of loan before scheduled time

Most banks levy 2% penalty on capital left in case of prepayment

In case of HDFC and ICICI Bank, the penalty is 3%

Most banks waive penalty if repayment is made with borrower’s own money. But they charge it if borrower takes a loan from another bank to prepay existing one

Banks penalise early repayment

Even though most banks operating in India impose penalty charges on premature repayment of loans, RBI’s reply to a quer filed under RTI noted that, “In the context of granting greater functional autonomy to banks, operational freedom has been given to scheduled commercial banks on all matters pertaining to banking transactions, including foreclosure of loans.”

The applicant asked RBI if it was aware of private and multinational banks levying foreclosure charges or penalties for premature payment of loans and what steps had been taken in this matter. RTI activist Subhash Chandra Agarwal also asked what steps had been taken by RBI to ensure that uniform interest rates were charged by all banks.

For credit card operations, RBI has advised banks to formulate a well documented policy and a fair practice code that charges interest rates that could depend on the payment or the default history of the cardholder.

“There should be transparency in levying of such differential interest rates... banks should upfront indicate to the credit card holder, the methodology of calculation of finance charges with illustrative examples, particularly in situations where a part of the amount outstanding is paid by the customer,” RBI’s CPIO said.

The central bank said in order to ensure transparency, banks should use only external or market-based rupee benchmark interest rates for pricing of their floating rate loan products.

“Banks should not offer floating rate loans linked to their own internal benchmarks or any other derived rate,” it said.
Source:- The Times of India 22 September 2009 Page No.1 Delhi

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