Fair Lending: RBI bars several practices

Lenders asked to mend ways immediately

Team Finserv | finserv@vinodkothari.com

Introduction

If fairness lies in the eyes of the beholder, the RBI’s eye is getting increasingly customer-centric. This fiscal year, the RBI has issued circulars aimed at fostering fairness and transparency in lending practices; these come at the backdrop of circulars last year on penal interest, adjustable rates of interest, release of security interests, strengthening customer service by Credit Information Companies and Credit Institutions, and establishing a framework for compensating customers for delayed updation or rectification of credit information. Recently on April 15, 2024, the RBI introduced a circular on Key Facts Statement (KFS) for Loans & Advances, with the goal of enhancing transparency and reducing information asymmetry regarding financial products offered by various regulated entities. This initiative aims to empower borrowers to make well-informed financial decisions. 

A new Circular, dated 29th April 2024 Fair Practices Code for Lenders – Charging of Interest comes down on some of the practices related to computation of rates of interest by lenders. . This Circular is all about stopping lenders from doing things that aren’t fair when it comes to charging interest. 

Applicability

The Circular applies to a wide range of financial institutions including Banks, Co-operative Banks, NBFCs, and HFCs. It is worth noting that this Circular comes into effect immediately upon its issuance.

Our analysis:

• Loan agreement in place, but disbursement has not happened:
  • If the lender has sanctioned a loan, but the disbursement has not happened, can the lender charge a commitment charge for the period upto disbursement?
    • In our view, the sanction amounts to a committed lending. Committed lending has liquidity implications for the lender, and also eats up regulatory capital. Therefore, it is quite okay for a lender to start charging commitment charge from the date of sanction till the date of disbursement, provided the same is clear in the KFS/terms of the loan.
  • If the disbursement does not happen for a particular period of time, can the lender revoke the sanction?
    • Yes, if the same is clear in the terms of the loan
• Interest to commence from the date of the disbursement:
  • What is the meaning of the date of disbursement? The funds actually leaving the bank account of the lender, or the cheque handed over?
    • Usually, handing over of a cheque is a common mode of making payments (unless the payments are being made in online mode – see below). Therefore, if there is an evidence of the cheque being handed over, the lender accounts for the disbursement from that date. If the cheque is not encashed, it appears as a reconciliation item. In our view it is okay to relate the date of handing over a cheque to the date of disbursement (assuming the cheque is good for immediate banking; it is not post-dated and subsequently does not bounce).
  • The RBI expects lenders to move to online modes of disbursement. What are the online modes of disbursement that are acceptable?
    • Disbursement through UPI
    • Disbursement to the bank account
    • Electronic Clearing System
    • Lender cannot transfer to a PPI wallet
• Advance EMIs to be considered while computing interest:
  • Advance EMIs should be captured while computing EMIs. If the EMIs are being collected in “advance” mode, rather than arrears, standard worksheet formulae (PMT) allows for advance EMIs to be considered. There is no further need to net off the advance EMI from the disbursement. For computing amortisation, the interest will be computed on the loan amount, minus the EMI
  • Does the advance EMI also have an interest component?
    • Yes. EMIs is an equated amount, payable through the term of the loan. Each EMI consists of interest and principal. The only difference is that while computing the EMIs, the disbursement was taken as net of the first EMI. That is to say, there is an interest component in the first EMI, but the interest is on the amount remaining after the first EMI. 

Applicability date and scope

• The circular as above is immediately applicable. Does it apply to existing loans too?
  • Each of the practices referred to above are treated by the regulator as unfair. It is not as if these were fair all this while and become unfair from a particular date. In fact, the Circular also says that the regulator during supervisory inspections has directed lenders to refund the excess interest if collected. Therefore, in our view, each of the above stipulations are applicable on all loans.
• Is the circular applicable only on “retail loans” as covered by Key Facts Statement (KFS) for Loans & Advances circular, or does it apply to all loans?
  • Coming from basic considerations of fairness, in our view, the Circular is applicable to all loans.

Actionables 

• REs to check whether the interest is being calculated from the date of actual disbursement rather than from the date of sanction of loan.
• REs to review their modes of disbursal of loans and to use online account transfers in lieu of cheques. In cases where loan is disbursed through cheques, we recommend REs take an acknowledgement when the cheque is handed over to the borrower
• REs to check whether they have received any intimation from RBI regarding the refund of any excess interest charged.

Related articles

1. The Key to Loan Transparency : RBI frames KFS norms for all retail and MSME loans
2. FAQs on Digital Lending Regulations 
3. FAQs on Penal Charges in Loan Accounts 
4. RBI streamlines floating rate reset for EMI-based personal loans