MUMBAI: Banks are said to be exploring ways to overcome the ‘pain points’ created by the new RBI regulations with regard to penal charges on borrowers.
The media tends to highlight the aspect of the new regulations that disallows the lenders to include penal charges in their net interest margin (NIM).
The bigger setback comes from the RBI mandate that penal charges cannot be charged on the entire loan outstanding.
Banks are said to be exploring ways to overcome the ‘pain points’ created by the new RBI regulations with regard to penal charges on borrowers.
The media tends to highlight the aspect of the new regulations that disallows the lenders to include penal charges in their net interest margin (NIM.
Only on overdue installment
Under the Reserve Bank of India’s (RBI) recent directive, financial institutions can no longer incorporate penal charges into the NIM or compute them on the full loan outstanding – a significant shift that’s expected to impact profitability, particularly for loans with high balances, such as housing loans.
Instead, the RBI has limited penal charges strictly to the overdue installment itself.
There were reports that net interest income of the state-owned banks was dented by 9-11 basis points (bps) in the second quarter of current financial year due to implementation of the new penal charges norms of the Reserve Bank of India (RBI).
What next?
“Let RBI disallow the lenders from including penal charges in their net interest margin (NIM), let the regulator stop them from applying penal charges on the entire loan outstanding, and only on the defaulted installment – I am sure they are smart enough to work around ways to make up for those losses,” said a former banker speaking with businessbenchmark.news from Mumbai.”
Banks are said to be designing ways to wriggle out of the clutches of new RBI regulations by increasing penal interest rates. Talking to businessbenchmark.news, an informed source said that some banks are planning to raise the penal charges multiple times.
“But still that won’t be comparable to the returns earned from imposing penal charges on the entire loan outstanding, however small it be, as loans such as housing loans are substantial in size by the very nature of such loans,” explained the source.
Sizeable revenue from penalties
Traditionally, penal charges have helped lenders in earning sizeable revenue inflows on large loans in early repayment stages when the outstanding principal is high.
‘Previously set around 1 per cent, the new penalties could surge up to 4 per cent or more in some cases, effectively creating a higher penalty for borrowers who miss installment payments – without breaching RBI’s guidelines,” remarked another source.
This shift could enable banks to recoup part of the lost NIM-related income, albeit through a separate income channel.
The RBI’s directive is aimed at fostering fair and transparent lending practices, limiting the ability of banks to profit excessively from borrower defaults and ensuring penal charges reflect only the missed payments.
Similar earlier directive from RBI
Earlier, banks and non-banking financial companies (NBFCs) were also prohibited from applying penalty-linked interest rate hikes across the loan tenure, addressing an industry trend where defaulted installments resulted in interest rate hikes on the entire loan.
The new rules, especially concerning penal charges on specific missed installments rather than on the total loan, reflect the RBI’s broader commitment to borrower protection.
This policy shift underscores the central bank’s ongoing efforts to ensure that penalties are used to disincentivise non-compliance rather than to augment core profitability metrics of banks like NIM.
However, as evidenced by rising penal interest rates, banks continue to find ways to buffer the financial effects of regulatory shifts on their revenue streams.
