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Tailored to Fit Practically: Disclosure for RPTs under Revised Industry Standards
FAQs on Standards for minimum information to be disclosed for RPT approval
– Payal Agarwal, Partner | payal@vinodkothari.com
Alternative Investment Funds (AIFs) are private investment vehicles registered with and regulated by SEBI. Private investment vehicles, as is understood, are investment vehicles that pool investments from investors on a private basis, and make investments in investee entities based on the investment objectives disclosed to the investors. The returns from such investments, net of the expenses incurred by the vehicle, is distributed back to the investors. A typical AIF structure would look like:
The general obligations of AIFs are provided in the SEBI (Alternative Investment Funds) Regulations, 2012 read with the circulars issued from time to time. In addition to that, the Standard Setting Forum for AIFs (SFA) formulates implementation standards for various compliance requirements, as required by SEBI from time to time.
As may be understood, the AIF takes funds from its investors and makes investments in the investees. As between the sponsor/ manager of the Fund and the investors, there is a fiduciary relationship – since the investment decisions taken by the fund manager is on behalf of the investors, and in accordance with the investment objectives disclosed to the investors. Investor protection and transparency and proper due diligence of the investees become crucial in the context of an AIF. As compared to a traditional company, the AIFs are intermediaries between the investors and investees. This article discusses the various compliance requirements as applicable to AIFs.
The responsibilities of the Investment Committee may be waived by the investors (other than the Manager, Sponsor, and employees/ directors of Manager and AIF), if they have a commitment of at least Rs. 70 crores (USD 10 billion or other equivalent currency), by providing an undertaking to such effect, in the format as provided under Annexure 11 of the AIF Master Circular, including a confirmation that they have the independent ability and mechanism to carry out due diligence of the investments.
The responsibilities of the Manager are complied through the Key Management Personnel of such Manager.
The Compliance Officer is responsible to report any non-compliance observed by him within 7 days from the date of observing such non-compliance.
The various roles and responsibilities at the different levels of the governance structure is discussed below.
The Code of Conduct, as prescribed under the AIF Regulations, puts forth various requirements applicable to the AIFs and other relevant entities. The Code of Conduct is applicable to various responsibility centers charged with the governance requirements in an AIF. The requirements are given in the Fourth Schedule to the AIF Regulations read with Para 13.3. of the AIF Master Circular.
The applicability to various stakeholders along with the requirements are given in the table below:
| Person covered by the CoC | Requirements to be adhered to under the CoC |
| AIF |
|
|
|
|
|
The AIFs, being institutional investors, it is mandatory for AIFs to comply with the Stewardship Code in terms of Para 13.4 of the AIF Master Circular. This is applicable in respect of investments in listed equity instruments. Annexure 10 of the Master Circular specifies the broad principles of stewardship and provides guidance for its implementation. Further, the AIFs are required to report the status of implementation of the principles atleast on an annual basis (periodicity may differ for different principles), through the website of the AIFs. Such report may also be sent as a part of annual intimation to its clients/ beneficiaries. An article on the stewardship responsibilities of institutional investors may be read here.
In order to ensure that the decisions of the AIF are taken in compliance with all applicable laws and regulations, PPM, investor agreements and other fund documents, detailed policies and procedures are required to be kept in place in terms of Reg 20(3). The policies are jointly approved by:
The Manager is required to ensure that the decisions taken by the AIF are in compliance with such policies and procedures.
Further, the policies should be reviewed periodically, on a regular basis and whenever required as a result of business developments, to ensure their continued appropriateness.
The AIF is required to file Private Placement Memorandum (PPM) with SEBI through a Merchant Banker for the launch of Schemes. The format of PPM is specified under Annexure 1 read with the requirements specified under various other circulars from time to time. In order to ensure that the activities of the AIF are in compliance with the terms of PPM, annual audit of the terms of PPM is required to be done. In this regard, the following needs to be noted:
Reg 20(14) of the AIF Regulations require the books of account to be audited by a qualified auditor annually.
Reg 23 read with Chapter 22 of the AIF Master Circular specifies the requirements with respect to the valuation of the investments of AIF. The valuation is required to be done by an independent valuer, on a half-yearly basis (may be made an annual requirement subject to consent of 75% of investors in value).
Eligibility criteria have been specified for acting as an independent valuer:
The Manager shall specifically inform the investors, the reasons/ factors for deviation in valuation, in case the deviation is more than:
In case of Cat III AIFs, the listed and unlisted debt securities are required to be valued by an independent valuer, and the NAV is required to be reported on a quarterly basis for close ended funds, and monthly basis for open ended funds.
Resolution of investor complaints is a role of the Manager of AIF [Reg 24 of AIF Regulations]. Reg 24A requires the Manager to redress investor grievances in a prompt manner, but within a maximum of 21 days from receipt of grievances. The AIF is required to be registered on the SCORES portal for receipt of investor grievances. Further, in terms of Reg 25, the dispute resolution mechanism provided by SEBI (SMARTODR) is applicable to AIFs as well. Refer details under Master Circular for Online Resolution of Disputes in the Indian Securities Market dated 28th December, 2023.
Further, in terms of Para 17.4 of the AIF Master Circular, the AIFs are required to maintain data on investor complaints received against the AIF/ its Schemes on a quarterly basis within 7 days from the end of the quarter, in addition to the disclosure in the PPM. The data includes the following:
| S. No. | Investor Complaints received from | Pending as at the end of the last quarter | Received | Resolved | Total Pending at the end of the quarter | Pending complaints > 3months | Average Resolution time ^ (in days ) |
| 1 | Directly from Investors | ||||||
| 2 | SEBI (SCORES) | ||||||
| 3 | Other Sources |
The AIFs act in a fiduciary capacity towards the investors, and manage the funds of the investors invested in the AIF. Thus, the decisions of AIF are required to be taken in the interests of the investors. Some matters require approval of the investors of a specified majority, prior to undertaking such activity:
| Regulatory reference | Matter requiring approval | Requisite majority in terms of value of investment |
| Reg 9(2) | Material alteration to fund strategy | 2/3rd of unitholders |
| Reg 13(5) | Extension of tenure of close-ended funds (upto 2 years) | 2/3rd of unitholders |
| Reg 15(1)(e) | Investment in associates or units of AIFs managed/ sponsored by its Manager, Sponsor or associates of its Manager or Sponsor | 75% of investors |
| Reg 15(1)(ea) | Purchase or sale of investments from/ to: Associates Schemes of AIF managed or sponsored by its Manager, Sponsor or associates of its Manager or Sponsoran investor who has committed to invest at least fifty percent of the corpus of the scheme of AIF | 75% of investors, excluding investor covered under (c) where purchase/ sale is from such investor |
| Reg 20(10) | Appointment of external members (other than ex-officio members) in Investment Committee other than as disclosed in the fund documents | 75% of investors |
| Reg 23(2) | Reducing frequency of valuation of investments from six months to 1 year | 75% of investors |
| Reg 29(9) | In-specie distribution of investments of AIF due to lack of liquidity or enter into liquidation period | 75% of investors |
The funds of the investors invested in the AIF are managed by the Manager and Sponsor in a fiduciary capacity. In order to ensure transparency, various disclosure requirements apply in terms of Reg 22 of the AIF Regulations – either on a periodic basis or upon the happening of certain events.
The periodic disclosures include:
Further, in terms of clause (g) of Reg 22, the following information is required to be disclosed within 180 days from the year end (60 days from the end of each quarter for Cat III AIF):
Any changes in terms of PPM or other fund documents are required to be intimated to the investors on a consolidated basis within 1 month from the end of each financial year [Para 2.5.3. of AIF Master Circular]
These events are required to be disclosed ‘as and when occurred’:
Reg 28 provides power to SEBI to seek such information from the AIFs, as may be required, from time to time. In addition to such powers, there are various specific reporting requirements that are applicable on AIFs under various applicable provisions. These include:
| Regulatory reference | Matters requiring reporting to SEBI | Timelines |
| Reg 20(12) | Any material change from the information provided at the time of application | Promptly |
| Reg 26 | Information for systemic risk purposes (including the identification, analysis and mitigation of systemic risks) | when so required by SEBI |
| Para 2.5.2 | Any changes in the terms of PPM and other fund documents, along with DD certificate from Merchant Banker | within 1 month from the end of FY |
| Para 15.1 | Reporting on investment activities of AIF in the format specified by SFA | 15 calendar days from end of each quarter |
| Para 15.2 | Any violations reported in the Compliance Test Report (refer detailed discussion below) | As soon as possible |
| Reg 20(11) r/w Para 15.4. | Investments of AIF that are in custody of the custodian | Quarterly |
An AIF, in its capacity of a SEBI-registered intermediary, is required to comply with the SEBI (Intermediaries) Regulations, 2008 read with the circulars issued thereunder. These include, for instance, compliance with the circulars/guidelines as may be issued by SEBI with respect to KYC requirements, Anti-Money Laundering and Outsourcing of activities [Para 13.5 of AIF Master Circular].
The guidelines with respect to anti-money laundering and KYC requirements are contained in a Master Circular dated 6th June, 2024 on the subject. Our various resources on KYC and anti-money laundering can be accessed here.
The manager of AIF is required to report the compliances with various applicable provisions of the AIF Regulations read with the circulars made thereunder, on an annual basis. CTR is submitted within 30 days from the end of the financial year, to the sponsor and trustee (in case AIF is set up as a trust). The trustee/ sponsor provides their comments on the CTR to the manager within 30 days from the receipt of CTR, based on which the manager shall make necessary changes and provide a response within the next 15 days.
A significant aspect of the CTR is that any violation observed by the trustee/ sponsor is required to be intimated to SEBI, as soon as possible. This requirement is in addition to the obligation of the Compliance Officer to report a non-compliance, within 7 days of becoming aware of the same. The format of CTR is provided in Annexure 12 of the AIF Master Circular.
SEBI specifies various compliances applicable to the AIFs from time to time. The compliances as applicable to the AIFs for the first time during FY 25-26 has been dealt with in our article Regulatory landscape for AIFs: what’s new? Further, there are certain requirements applicable on special categories of AIFs, viz., angel funds, Special Situation Funds, Social Venture Funds etc. Further, there are various prudential requirements applicable to receipt of funds from investors and making of investments by the AIFs.
See our other resources on AIFs:
[1] Associate means:
[2] The conditions include:
(a) Minimum net worth of the Sponsor or Manager of at least twenty thousand crore rupees at all points of time;
(b) fifty per cent or more of the directors of the Custodian do not represent the interest of the Sponsor or Manager or their associates;
(c) the Custodian and the Sponsor or Manager of AIF are not subsidiaries of each other;
(d) the custodian and the Sponsor or Manager of AIF do not have common directors; and
(e) the Custodian and the Manager of AIF sign an undertaking that they shall act independently of each other in their dealings of the schemes of AIF.
– Pammy Jaiswal and Sourish Kundu | corplaw@vinodkothari.com
The presentation of the profit and loss account has been outlined under the Schedule III of the Companies Act, 2013 (‘Act’) and the profit computation method has been provided for under the applicable accounting standards [See IND AS 1]. The basic principle is to showcase a true and fair view of the financial position of a company. Having said that, it is also significant to mention that the Act provides for an alternative method for computing net profits, the basic intent of which is to arrive at an adjusted net profit which does not have elements of unrealised gains or losses, capital gains or losses and in fact any item which is extraordinary in its very nature. The same is contained under the provisions of section 198 of the Act. This section, unlike the general computation method, has a limited objective i.e., calculation of net profits for managerial remuneration as well as corporate social responsibility.
There are four operating sub-sections under section 198 which provides for the adjustment items:
It is important to note that items other than those mentioned above need not be specifically adjusted unless their nature calls for adjustment under the said section. Now if we discuss specifically for items in the nature of Expected Credit Loss (‘ECL’) for companies following IND AS, it is important to understand the nature of ECL in the context of making adjustments under section 198 of the Act. See our write on Expected Credit Losses on Loans: Guide for NBFCs.
Reference shall be drawn from Ind AS 109 which defines ‘credit loss’ as ‘the difference between all contractual cash flows that are due to an entity in accordance with the contract and all the cash flows that the entity expects to receive (i.e. cash shortfalls), including cash flows from the sale of collateral held.’ ECL is essentially a way of estimating future credit losses, even on loans that appear to be fully performing at the time of such analysis (Stage 1 assets). It is based on expected delays or defaults, and the estimated loss is recorded as a charge to the profit and loss account, based on a 12-month probability of default.
As per Ind AS 109, ECL is used for the recognition and measurement of impairment on financial assets both at the time of origination as well as at the end of every reporting period. ECL is a forward-looking approach that requires entities to recognize credit losses based on the probability of future defaults/ delays.
However, this does not result in a reduction in the carrying value of the asset (unless the asset is already credit-impaired, i.e., Stage 3). In that sense, while ECL reflects asset impairment, it does not operate like a direct write-down. And unlike conventional provisioning, ECL is not a “provision” under traditional accounting – it is a loss allowance rooted in forward-looking estimations. Further, it is also important to understand that the booking of ECL does not mean that there has been a credit loss in the actual sense, the same is a methodical manner of estimating the probable default risk association with the asset value.
Section 198 requires excluding unrealised or notional adjustments, such as fair value changes or revaluation impacts in terms of Section 198(3) of theAct.
The section also refers specifically to actual bad debts, under Section 198(4)(o). This raises the natural interpretational question: should model-driven, probability-weighted ECL charges – which do not reflect realised losses – really be allowed to remain deducted while computing such customised profits? Well, the answer lies in the requirement and nature of such an item being required to be deducted from the profit and loss account under IND AS 109.
The question around the treatment of ECL can be viewed from two perspectives. The first being the nature of ECL and the second on the routine treatment and calculation of ECL. If we look at the nature, it is clear that while it is imperative for companies to compute ECL at the time of origination as well as at the end of every reporting period, it is important to note that there is no loss or default in the actual sense. This means that the amount computed as ECL has not been an actual default.
On the other hand, if we look at the need for such computation and the methodical approach to arrive at the value of ECL, the same is likely to be considered as a usual working charge which is charged to the profit and loss account. Accordingly, we have come across two possible and permissible approaches to the treatment of ECL while computing the profits under section 198. The same has been discussed below with the help of illustrations.
Approach 1: Disallowing ECL in the year of its booking and subsequent adjustment of bad debt
| Year 1 | Year 2 |
| PBT – 1000 Depreciation – 20 ECL – 40 Loss on sale of fixed asset – 15 | PBT – 1200 Depreciation – 20 ECL – 35 Actual Bad Debt – 15 Profit on sale of equity shares – 25 |
| Year 1 | Amount | Year 2 | Amount |
| PBT | 1000 | PBT | 1200 |
| Depreciation | – | Depreciation | – |
| Add: ECL | 40 | Add: ECL | 35 |
| Add: Loss on sale of fixed asset | 15 | Less: Profit on sale of equity shares | (25) |
| PBT u/s 198 | 1055 | PBT u/s 198 | 1210 |
Notes:
Approach 2: Allowing ECL in profit computation and netting off actual bad debt from the same in subsequent period
| Year 1 | Year 2 |
| PBT – 1000 Depreciation – 20 ECL – 40 Loss on sale of fixed asset – 15 | PBT – 1200 Depreciation – 20 ECL recovered – 35 Actual Bad Debt – 15 Profit on sale of equity shares – 25 |
| Year 1 | Amount | Year 2 | Amount |
| PBT | 1000 | PBT | 1200 |
| Depreciation | – | Depreciation | – |
| ECL | – | ECL | – |
| Add: Loss on sale of fixed asset | 15 | Actual bad debt | – |
| ECL recovered | – | ||
| Less: Profit on sale of equity shares | (25) | ||
| PBT u/s 198 | 1015 | PBT u/s 198 | 1185 |
Notes:
All listed companies are required to comply with Ind AS and given that an instance of a company having nil receivables is a rare occurrence, the discussion on how ECL is to be treated while computing net profit in terms of Section 198 becomes more than just an academic debate.
As long as the impact of any P&L item being extra ordinary in nature is taken off from the profits computed u/s 198, the same serves the purpose and intent of section 198 of the Act. ECL, while valid for accounting, is fundamentally an estimated, non-actual loss. It exists because accounting standards demand alignment of income with credit risk and not because a real outflow has occurred. However, it cannot be said that ECL already deducted while calculating profit before tax as per applicable accounting standards will be reversed while calculating profits in terms of Section 198.
Further, given that ECL is based on expectation calculated using due accounting principles, the actual bed debt, if within the ECL limit, does not impact the P&L. On the contrary, in case of the actual bad debt being in excess, the P&L warrants a subsequent debit of the net amount. For example, under approach 2 if the actual bad debt would have been 50, i.e. in excess of the ECL booked in the previous period by 10, the normal profit computation would have allowed a debit of 10.
In fact, both the approaches lead to the fulfilment of the intent of section 198 and hence, it is not necessary to consider any one approach as correct. Having said that, it is imperative to follow uniform practice in this regard in the absence of which the profits u/s 198 may be impacted.
Therefore, where the statutory and accounting frameworks intersect – but are not necessarily aligned – companies must adopt a carefully considered, principle-based approach as even a single line item like ECL can materially influence the base for managerial remuneration and CSR spending unlike other estimate based items such as revenue deferrals viz. sales returns or warranties, which are made as a matter of accounting prudence, but does not represent outflows for statutory computation purposes. Accordingly, there is no reason for deviating from the Indian GAAP principles for the purpose of customised calculation of net profits for specific purposes.
Read more:
Cash in Hand, But Still a Loss?
-Team Finserv | finserv@vinodkothari.com
Pre-payment means paying a loan before its scheduled due date or end date. Borrowers may choose to pre-pay when they have extra cash or find better loan terms from another lender. While this may help the borrowers reduce their overall interest cost or improve their loan terms, lenders have traditionally charged a fee for such early repayment. These pre-payment charges are meant to cover the lender’s loss of expected stream income. So, from the lender’s perspective, pre-payment charges help make up for this loss. However, from the borrower’s perspective, such charges can be unfair especially on floating-rate loans, where the lender has a right to revise the interest rate at periodic intervals based on market conditions. Floating-rate loans already give lenders the ability to revise rates charging a penalty for early repayment adds another burden for the borrower.
The regulatory stance on prepayment charges has evolved over time, beginning with a prohibition on such charges in case of floating rate home loans, followed by an extension to cover personal loans and now, to include even business loans extended to MSEs and individual borrowers. [Evolution of this regulatory bar is discussed in the later part of the present FAQs]
The present extension of the regulatory bar on levy of prepayment charges in case of floating rate business loans extended to MSE and individual borrowers, stems from the RBI supervisory reviews. The reviews conducted by RBI indicated divergent practices amongst the regulated entities with regard to levy of pre-payment charges in case of loans sanctioned to MSEs which lead to customer grievances and disputes. Further, certain REs were 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.
To address this, RBI in October 2024 in the Statement on Developmental and Regulatory Policies, proposed that the ambit of prohibition on levy of pre-payment charges on floating rate loans extended to individuals be expanded to also include MSE borrowers. Accordingly, a draft circular was released on February 21, 2025. Based on the comments received and supervisory findings, the final Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025 have been issued on July 2, 2025 (‘Prepayment Directions’), effective from January 01, 2026.
The Prepayment Directions consolidate the diverse practices and provisions on levy of prepayment charges for all lenders. This would ensure uniformity with regard to prepayment of various loans by borrowers of banks and NBFCs (including HFCs).[1]
We have analyzed and collated questions on the various nuances and impact of the Prepayment Directions for better understanding in the form of FAQs as listed hereinafter:
A.… Applicability and Conceptual Understanding:
1…. What is the regulatory regime for prepayments/prepayment charges?
2…. Who all are covered under the Prepayment Directions?
3…. What will be the applicability of the Prepayment Directions in case of the following products:
4…. When do these Directions come into force?
7…. Whether the provisions of Prepayment Directions are applicable to demand and call loans as well?
8…. Does the provision apply only in case of part pre-payment or foreclosure as well?
9…. What is the difference between a fixed rate and floating rate interest loan?
B.… Regulatory requirements in case of floating rate loan:
23.. Whether the limit of ₹50 lakh also applies in case of floating rate loan disbursed by a HFC?
24.. What is the applicability of the Prepayment Directions in case of NBFC-BL?
C.… Regulatory requirements in case of fixed rate loans:
28.. Can prepayment charges be levied on fixed rate housing loans disbursed by an HFC?
D.… Prepayment Charges and Conversion Treatment for CC and OD facilities:
29.. How are cash credit/ overdraft facilities treated for levying pre-payment charges?
30.. How are conversions from OD/CC to term loans treated?
E.… Restrictions on Prepayment:
32.. Will lock-in period be allowed in case of hybrid ROI loans?
35.. Can an RE levy prepayment charge, if the same is effected at its own instance?
36.. What is the meaning of “pre-payment is effected at the instance of the RE”?
F.… Co-lending and Digital Lending:
39.. What are the disclosure requirements under the Prepayment Directions?
40.. How should the disclosure be given in KFS?
42.. Can REs implement a slab-based charge to be levied based on prepaid percentage?
43.. How will consortium or syndicated loans be handled?
Pre and post January 01, 2026 i.e., the date from which the Prepayment Directions will become applicable, the regulatory regime for levy of prepayment charges is captured below:
| Type of NBFC | Up to December 31, 2025 | From January 01, 2026 |
| NBFCs (Other than HFCs) | Para 45.7.4 of the SBR Master Directions;Board approved policy on levy of prepayment charges. | Prepayment Directions;Board approved policy on levy of prepayment changes. |
| HFCs | Para 85.6 and 85.7 of the HFC Master Directions;Board approved policy. | Para 85.6 of the HFC Master Directions;Prepayment Directions;Board approved policy on levy of prepayment changes. |
These Directions shall apply to all commercial banks (excluding payments banks), cooperative banks, NBFCs (including HFCs) and All India Financial Institutions.
The applicability of the Prepayment Directions in case of the above listed products shall be as follows:
| Type of product | Applicability |
| Revolving lines of credit | A revolving line of credit is a type of loan arrangement that provides borrowers with access to a predetermined amount of funds, which they can borrow, repay, and borrow again as needed. Therefore, there is no question of levy of prepayment charges during the facility period. However, with respect to a situation wherein the borrower does not opt to renew the facility, the applicability will be as provided in para 7 of Prepayment Directions. For detailed discussion, see response. See also, our article on revolving lines of credit. |
| Working capital facilities | Working capital facilities are generally in the nature of term loans. Accordingly, covered by the Prepayment Directions. As regards the question of levy of prepayment charges, see conditions in (3) below. |
| Loan to companies | In case of term loans extended to companies, the applicability will be checked basis the following: Is the borrower an MSE?Is the facility a floating rate loan?Is the lender an RE? If answers to all the above questions are positive, Prepayment Directions will be applicable. Next, with respect to whether prepayment charges can be levied, the same shall depend on who the lender is. That is to say, NBFC-UL and Banks cannot levy prepayment charges on the floating rate business loans to MSEs. In case of NBFC-ML, there is a limit of ₹50 lakh up to which the same cannot be levied. NBFC-BLs shall be guided by their respective board approved policy. |
| Financial lease | Financial lease by its very nature, are akin to loans. The lease rentals received by the lessor is divided in two parts, the interest component and the principal. However, given that the lease rentals are fixed at the time of entering into the agreement, and the interest is on a fixed rate basis, to that extent, in our view, any prepayment should be guided by the board approved policy. |
| Discounting of commercial invoices/bills of exchange | The question in case of bills discounting could be what if after the lender has discounted the bill, the borrower prepays the loan amount. In this scenario, can the borrower ask the discounting agency to repay the discounting charges proportionately? Here it is to be noted that prepayments are contingent in nature. At the time when the bill was discounted, none of the parties were certain about it. Accordingly, in our view, there should not be a question of asking the discounting agency to repay the discounting charges. |
These apply to all loans and advances sanctioned or renewed on or after January 1, 2026. Any loans sanctioned before the said date shall not be covered (for compliances with respect to such loans, you may refer to our resource here).
The Prepayment Directions apply based on the sanction date. A loan sanctioned before January 1, 2026 is outside the scope, even if disbursed later. Conversely, any loan sanctioned on or after January 1, 2026 falls within scope.
Yes. Any fresh sanction or renewal on or after the effective date must comply with the pre-payment charge norms.
Footnote 2 of the Prepayment Directions clarifies that the term ‘loans’ shall include term loans as well as demand loans. However, in the context of demand and call loans, it is to be noted it could be of two types, (i) simple demand loan and (ii) demand and call loans. In case of plain vanilla demand loans, the lender can ask the borrower to pay back at any point of time. Since such payment would be at the instance of the lender, the same should not be considered for levy of any prepayment charges. But in case of demand and call loans, the borrower also carries a right to prepay. Therefore, in case of demand and call loans, there cannot be a question of levy of prepayment charges.
The distinguishing factor between pre-payment and foreclosure is that the former means early payment of scheduled installments, while the latter implies early payment of the entire outstanding amount leading to early closure of the loan term. The Prepayment Directions apply equally to part prepayments and foreclosure (full prepayments). Para 5(iii) of the Prepayment Directions makes it clear that the exemptions in paras 5(i) and 5(ii) apply “irrespective of the source of funds used for pre-payment of loans, either in part or in full, and without any minimum lock-in period”. Likewise, for facilities outside those blanket exemptions, any prepayment charge on a term loan must be “based on the amount being prepaid” (whether that is a tranche or the entire balance), and for CC/OD closures, charges (if any) are capped at the sanctioned limit on closure before the due date Hence, going by the intent of the regulator, the provisions should apply on both partial as well as full prepayment by the borrower and hence, covering both prepayment charges as well as foreclosure charges.
A fixed rate loan refers to one where interest rates remain locked throughout the loan tenure, while a floating rate term loan refers to interest rates that are subject to resets with reference to a benchmark rate or reference rate. Usually, the floating rate has a fixed spread over the said reference rate. Reference rate is determined by taking into account the cost of funds, credit cost, liquidity cost, operating expenses, expected return on equity, etc. Lenders have the option to change the reference rate prospectively depending on changes in the input factors.
What would one say where the loan has a fixed rate, and the lender has the option to change the rate during the loan tenure, say, with the concurrence of the borrower? This is still a fixed rate loan. A floating rate facility is one with a fixed spread over a benchmark rate.
In floating rate too, variations of interest rate happen only on “reset dates” or reset periods; therefore, between the reset dates, the interest rate still remains fixed.
In case of dual rate or special rate i.e., a combination of fixed and floating, the Prepayment Directions will be applicable if the loan is on floating rate at the time of prepayment. Prepayment at the time when the loan is on fixed rate shall be governed by the board approved policy of the lender. Note for HFCs, the extant HFC Directions also prohibit charging prepayment charges on fixed rate housing loans foreclosed with own sources (refer response here).
Refer response above, the status on the actual pre-payment date determines the levy of prepayment charges. If the loan is on a floating rate at the point of prepayment, the floating rate pre-payment norms shall apply, regardless of the loan being at fixed rate earlier.
The rationale behind levy of prepayment charge is to deter the customers from prepaying the loan amount which if paid before the due date shall result in revenue loss to the lender. Therefore, the prepayment charges, if leviable, must be levied on the amount prepaid i.e., ₹50 in the present case.
The exemption from prepayment charges on floating rate business loans upto ₹50 lakh applies only when the lender at the time of sanction is in one of the categories listed in para 5(ii)(b) of the Prepayment Directions, namely, SFB, RRB, Tier-3 Primary (Urban) Co-operative Bank, State/ Central Co-operative Bank or an NBFC-ML.
In the given scenario, the borrower’s floating rate business loan of ≤ ₹50 lakh was sanctioned by an NBFC-BL. NBFC-BLs are not included in para 5(ii)(b), so no automatic exemption applied at sanction. Even though the same financial entity has been reclassified as an NBFC-ML, this post sanction change does not impact the exemption provided at the time of sanction. The loan continues to be governed by the governing regime and fee disclosures that were in place on the sanction date.
Therefore, just because the loan was originally sanctioned by an NBFC-BL, it was never covered by the ₹50 lakh cap under para 5(ii)(b). Prepayment charges remain permissible subject to board-approved policy and the disclosures already made. Reclassification to NBFC-ML after sanction does not convert the loan into one that is automatically exempt, the lender may only charge the fee that was originally disclosed and cannot levy any new or higher charges/penalty.
The applicability of the Prepayment Directions should be based on the type of loan and the borrower to whom the loan has been extended. Here, given that the obligations and liability of the borrower and co-borrower is coextensive, in our view, the applicability of prepayment charges shall be determined considering both the borrowers. In our view, in case either the borrower or co-borrower is an individual or MSE, the restrictions prescribed under the Prepayment Directions shall be applicable. Hence, prepayment charges cannot be levied in the following scenarios, (in case of loan for business purpose by NBFC-ML, only upto sanction limit of ₹50 lacs):
| Main borrower/Applicant | Co-borrower/Co-applicant |
| Individual | MSE |
| Individual/ MSE | Non-MSE/ Non-Individual |
| Non-MSE/ Non-Individual | Individual/ MSE |
Accordingly, in case applicable lenders intend to take an exposure on non-MSE or non- Individual and levy prepayment charges, it may refrain from having any individual or MSE as the co-borrower. The levy of prepayment charges, however, shall not be impacted in case individuals or MSE are acting as guarantors.
To understand the restrictions and applicability, the following approach may be applied by the lenders:
Based on the response to the aforesaid question, the various permutations and combinations that can be arrived at, has been demonstrated below:
Further, the snapshot of the applicability is as follows:
| Levy for Prepayment Charges | |||||||
| Type of Loan | Type of Interest | End Use/ Sanctioned Amount | NBFC-BL | NBFC-ML (other than HFCs) | NBFC-UL (other than HFCs) | HFCs | Banks (excluding payment banks) |
| Loans to Individuals | Fixed Rate | For Personal Use | Can be levied | Can be levied | Can be levied | Can be levied (except for housing loans foreclosed with own sources) | Can be levied |
| For Business Use | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied | ||
| Floating Rate | For Personal Use | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | |
| ≤ ₹50 lacs sanctioned for Business Use | Can be levied | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | ||
| > ₹50 lacs sanctioned for Business Use | Can be levied | Can be levied | Cannot be levied | Can be levied (except for HFCs in Upper Layer) | Cannot be levied | ||
| Loans to Micro Small Entities | Fixed Rate | Any quantum | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied |
| Floating Rate | ≤ ₹50 lacs sanctioned | Can be levied | Cannot be levied | Cannot be levied | Cannot be levied | Cannot be levied | |
| > ₹50 lacs sanctioned | Can be levied | Can be levied | Cannot be levied | Can be levied (except for HFCs in Upper Layer) | Cannot be levied | ||
| Loans to non-MSEs | Fixed | Any quantum | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied |
| Floating | Any quantum | Can be levied | Can be levied | Can be levied | Can be levied | Can be levied | |
Note that in cases where pre-payment charges can be levied, the same has to be as per the internal board approved policy.
In case of floating rate loans, the Prepayment Directions provides as follows:
With respect to the levy of prepayment charges, the restrictions applicable in case of NBFCs and Banks for floating rate business loan to individual and MSE, before and after the notification of the Prepayment Directions, can be understood as follows:
| Type of RE | Before January 1, 2026 | From January 1, 2026 |
| Bank/NBFC-UL | No regulatory bar on levy or pre-payment charges. The levy shall be as per the board approved policy of the lender. | Prepayment charges cannot be levied. |
| NBFC-ML | Prepayment charges cannot be levied on loans with sanctioned amount/ limit up to ₹50 lakh | |
| NBFC-BL | No change |
In case of floating rate personal loan to individuals, prepayment charges cannot be levied by banks and NBFCs (including HFCs). There is no change in this requirement.
Para 5(ii)(b) of the Prepayment Directions uses the phrase “sanctioned amount/ limit up to ₹50 lakh” for not levying the prepayment charges. The actual disbursement will not be relevant.
The limit of ₹50 lakh in case of floating rate business loan extended by an NBFC-ML to individuals or MSEs is to be checked at entity level.
In this case, it is understood that a same individual borrower has availed two loan facilities, (i) personal loan and (ii) business loan on floating rate basis from the same NBFC-ML. Now, given the divergent provisions in case of personal loans and business loans, in our view, from the perspective of levy of prepayment charges, both the facilities should be checked on a standalone basis.
Refer response to Q15, in the present case, given that the sanction amount is more than ₹50 lakh, in our view, the lender being an NBFC-ML can levy the prepayment charges, as per its internal board approved policy.
Pursuant to para 8 of the KFS Circular, “Any fees, charges, etc. which are not mentioned in the KFS, cannot be charged by the REs to the borrower at any stage during the term of the loan, without explicit consent of the borrower.” Also, in cases where the KFS is not required to be provided, as a matter of fair lending practice, any subsequent charges/penalties cannot be levied which were not leviable/levied at the time of sanction of the loan.
In this case, the ₹1 crore floating rate loan was sanctioned by an NBFC-UL, which pursuant to para 5(ii)(a) of the Prepayment Directions is barred from levying any prepayment charges on floating rate business-purpose loans to individuals and MSEs, irrespective of loan size. Consequently, the original KFS and loan agreement carried no prepayment charges. Further, upon assignment, the NBFC-ML steps into the shoes of the original lender and must honour all original terms. It shall be noted that assignment is not a fresh sanction or renewal. Therefore, even upon assignment, the assignee (NBFC-ML) cannot levy prepayment charges upon the borrower’s prepayment, even though the loan amount exceeds ₹50 lakh due to the following reasons:
Under the Prepayment Directions, floating rate loans to individuals and MSEs for business purposes enjoy a prepayment charge exemption up to ₹50 lakh when sanctioned by an NBFC-ML. HFCs, by default, fall under NBFC-ML classification. Therefore, an HFC, irrespective of its asset size, cannot charge a prepayment penalty on such loans up to ₹50 lakh as per para 5(ii) of the Prepayment Directions. It shall be noted that floating-rate loans above ₹50 lakh remain outside this cap and may attract pre-payment charges as per the HFC’s board-approved policy.
It may be further noted that in case of housing loans, extended to individuals for construction of a house, by HFCs, ₹50 lakh threshold under para 5(ii) of the Prepayment Directions shall not be relevant since such housing loans would be said to be for purposes other than business.
para 5(i) provides a blanket prohibition on pre-payment charges for floating-rate loans to individuals for non-business purposes, irrespective of the loan size.
NBFC-BL shall not levy prepayment charges for all floating rate loans granted for purposes other than business to individuals, with or without co-obligant(s). As regards the business loans, any levy of prepayment charges shall be governed by the board approved policy of the lender.
In the Prepayment Directions, floating-rate loans are inferred on the interest-rate basis, not by how frequently the rate resets. As a result:
To conclude, the provisions of the Prepayment Directions do not provide for any timeline for reset of the rates, accordingly, as long as the loan is at a floating rate, irrespective of the timeline for reset, the provisions for floating rate loans, shall apply.
In case of fixed rate loans, the levy of pre-payment charges, if any, shall be based on the board- approved policy of the lender (Para 6 of Prepayment Directions). Such policy shall, at a minimum, cover the following:
There has been no change in case of fixed rate loans post enactment of the present Prepayment Directions.
In terms of para 85.6(a) of the HFC Directions, HFCs shall not charge pre-payment levy or penalty on pre-closure of housing loans in case of fixed interest rate loan if the same is preclosed by the borrower out of their “own sources”. The expression “own sources” for the purpose means any source other than by borrowing from a bank/ HFC/ NBFC and/or a financial institution.
In case of CC and OD, pre-payment is basically the closure of the facility before the agreed due date. As per para 6 of the Prepayment Directions, for early closure of the facility, pre-payment charges shall be levied on an amount not exceeding the sanctioned limit. However, no charges shall be levied if the borrower intimates his/ her/ its intention not to renew the facility before the period as stipulated in the loan agreement and the facility gets closed on the due date.
Converting the outstanding OD/CC balance into a term loan triggers a new sanction. Accordingly, in our view, if this conversion is before the agreed closure date of the facility, the response as is mentioned in Q24 above shall apply. However, if the conversion is at the instance of the lender, it shall not be considered for levy of prepayment charges.
Prescribing a minimum lock-in period would have the same effect as a prepayment penalty. Hence, lenders are restricted from prescribing any minimum lock in period in case of floating rate loans to individuals for personal use and to individual/ MSEs for business purposes as per Para 5(i) and 5(ii).
| Restriction | Floating Rate loans covered under para 5 (i) and (ii) | Other loans |
| Minimum lock-in period | Cannot be specified by the lender. | Reasonable lock-in say in case of long tenure loans can be specified. |
| Minimum amount/ percentage of prepayment | The provisions are silent on the same, however, in our view, given the operational issues, a reasonable amount/ number of EMIs can be specified to be considered for prepayment.. | A reasonable amount/ number of EMIs can be specified considering operational challenges. |
| Maximum instances of prepayment option | The provisions are silent on the same, however, in our view, given the operational issues, a reasonable number can be specified for the borrower to exercise the prepayment option. | Can be specified based on operational issues. |
It may be noted that refusing to accept early repayment of debt would be considered an “unfair contract” under Consumer Protection Act, 2019 (Section 2(46)). Hence, in cases where the lender may impose a prepayment penalty but it has prescribed restrictions such as lock-in period or minimum percentage of prepayment, the same may be seen as an unfair practice.
The bar on levy of prepayment charges under the Prepayment Directions is on floating rate business loans to individuals and MSE. Now, if the interest rate on the loan is structured in such a manner that for the initial period of say, 2 years, it is on fixed rate basis, and thereafter floating, in our view, lock-in restrictions may be applicable for the period when the loan is on fixed rate.
Given commercial considerations (such as various costs incurred by the lender, like the admin costs), a hybrid interest rate model with part-fixed and part-floating rate of interest may be explored by lenders (which is practiced by many housing finance institutions).
During the fixed-rate period, the lender may have a lock-in period / levy prepayment penalty as per its Board Approved Policy as per Para 6 (except in case of HFCs where borrower has prepaid with own funds). During the floating rate phase, there cannot be any lock-in period, however, a reasonable minimum amount/ minimum number of EMIs/ maximum instances can be specified to be considered for prepayment
As regards the contents of the policy, in our view, considering the intent and requirement in the present case, the policy among other things must also ensure the following:
Para 8 of the Prepayment Directions clarifies that an RE shall not levy any charges where pre-payment is effected at the instance of the RE.
The literal meaning of the phrase is, whenever the lender is asking the borrower to prepay the loan before the due date. This would refer to such cases where the lender has a right to force prepayment/ accelerate repayments upon occurrence of such events as specified in the loan agreement. For instance, occurrence of any event of default or any adverse material change, consequent to which the lender may ask the borrower to either prepay the loan or accept higher interest. Further, in case of CC/OD, the lender may offer the borrower to convert the facility to a term loan before the end of term of the facility.
Given the dissimilar applicability of the provisions of the Prepayment Directions in case of NBFC-UL (cannot levy at all), ML (cannot levy where sanctioned amount is ≤ 50 lakh) and BL (to be guided by the board approved policy), the ambiguity w.r.t. the applicability of the Prepayment Directions will arise in case of co-lending by these entries.
Ideally, the prepayment penalty should be levied by the lenders on their respective loan share. Hence, the borrower should be informed and communicated about the levy of prepayment charge on one part of the loan (co-lent by NBFC-BL) and no charges on the other part (co-lent by NBFC-UL). At the time of prepayment, the amount shall be distributed between the co-lenders based on the respective loan share and the prepayment charges shall only be levied on one part.
Alternatively, the lenders may mutually agree to apply the restriction if applicable on any one of the co-lender, for the entire loans originated under a co-lending arrangement.
Charges levied by UPI apps for making the payments are not linked with the prepayment charges. Accordingly, as per the usage terms of the application, the same may be levied.
The applicability or otherwise of pre-payment charges shall be clearly disclosed in (i) sanction letter and (ii) loan agreement. Further, in case of loans and advances where Key Facts Statement (KFS) is to be provided as specified in the Circular dated April 15, 2024 on ‘Key Facts Statement for Loans and Advances’ i.e., in cases of all retail and MSME term loan products, the applicability or otherwise of the prepayment charges shall also be mentioned in the KFS.
For loans requiring a KFS, the pre-payment charges section must list the exact charges or state “nil” if no charges apply.
The RE has the discretion to waive off the prepayment charges based on the merits of the specific case of the borrower. However, RE shall not levy any charges/ fees retrospectively at the time of pre-payment of loans, which were waived off earlier by the RE. [Refer Para 10 of the Prepayment Direction]
Yes, where charges are permissible, REs may structure a schedule of fees corresponding to the prepaid amount/percentage. This slab must be transparent, disclosed upfront and applied uniformly.
In our view, pre-payments charges, if applicable, shall be as per the loan agreement executed between the lenders and borrower.
[1] Read our article “Do you pay to prepay?” analysing the Directions at: https://vinodkothari.com/2025/07/levy-of-prepayment-charges/
Register for our Certificate Course on RPTs, see details here – https://vinodkothari.com/2025/08/12-hours-certificate-course-on-nuts-and-bolts-of-related-party-transactions/
Our brief note on the Industry Standards can be read here.
Our other resources on RPTs can be accessed here.
RBI imposes restrictions on imposition of prepayment charges on floating rate loans
– Anita Baid, finserv@vinodkothari.com
Following the announcement made in the Statement on Developmental and Regulatory Policies dated October 9, 2024, the RBI had released a draft circular inviting comments from stakeholders on its proposed guidelines regarding the levy of foreclosure charges and pre-payment penalties on loans.
Based on the comments received and supervisory findings, the final Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025 have been issued on July 2, 2025 (‘Prepayment Directions’).
Read more →