RBI Directions on Lending to Related Parties: Frequently Asked Questions
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Gone but Not Forgotten: FAQs on Loan Write-offs
Team Finserv (finserv@vinodkothari.com)
Background
Loan write-offs in case of banks has been a consistent practice, and has been sharply criticized in several forums. Loan write-offs constitute a significant amount: Between FY 2015 and FY 2024, Scheduled commercial banks wrote off loans worth ₹12.3 lakh crore, with a ₹9.9 lakh crore written off in just the last five years (FY 2020 to FY 2024).
| Year | Amount (in INR Crore) |
| 2023-24 | 1,70,270 |
| 2022-23 | 2,08,037 |
| 2021-22 | 1,74,966 |
| 2020-21 | 2,02,781 |
| 2019-20 | 2,34,170 |
| Total | 9,90,224 |
Table 1: Loan write-offs by banks in the last 5 years (FY 20 – 24)
On the other hand, global supervisors and developmental bodies have always advocated a sound loan write-off policy for uncollectable loans. In its 2014 paper, IMF says:
“Banking supervisors should have a general policy requiring timely write-off of uncollectible loans and assist banks in formulating sound write-off criteria. The benefits of timely write-offs of uncollectible loans are numerous … A bank should write off a loan or portion of a loan when it is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted. This does not have to be preceded by exhausting all legal means and giving up contractual rights on cash flows. This also does not mean that the loan has absolutely no recovery or salvage value, but rather that it is not practical or desirable to defer writing off this essentially worthless asset even though partial recovery may be realized in the future.”
The IMF paper also discusses the potential downside of the write-off – that the reported NPLs would be lower, however, it argues that the write-off gives a better picture of the provision coverage.
European regulators have also extensively recommended loan-write off policy. In a 2017 paper1, European Central Bank says:
“An entity should write off a financial asset or part of a financial asset in the period in which the loan or part of the loan is considered unrecoverable. For the avoidance of doubt, a write-off can take place before legal actions against the borrower to recover the debt have been concluded in full. A write-off does not involve the bank forfeiting the legal right to recover the debt; a bank’s decision to forfeit the legal claim on the debt is called “debt forgiveness”.
The World Bank in a 2019 paper2 has, likewise, given several benefits of a write-off as compared with provisioning:
“An ambitious NPL write-off policy provides several benefits for banks and the financial system.
Firstly, by resolving NPLs banks can focus on core business (i.e., financial intermediation) in terms of time and resources. By efficiently dealing with NPLs, including writing off, the bank can allocate its productive resources to new lending, instead of becoming an asset management company of “bad assets”.
Secondly, while the main aim is the liquidation of assets with low recovery prospects, the consequence of an NPL write-off typically is a decrease of the NPL ratio in banks. Country experience shows that this is a particularly efficient way to decrease the NPL ratio quickly …
Thirdly, there are no negative effects on financial statements, provided that loans are already fully provisioned and losses already recorded in the P&L statements. Fourthly, a decrease in NPL ratio should improve a ratings agency assessment of credit risks in the bank or in the financial system.”
IFRS 9 (Indian version Ind AS 109) specifically permits write-off, though its precursor, IAS 39 did not have a specific provision.
Originally, write-off in India seems to have been inspired by tax considerations, as a mere provisioning qualifies for a conditional and limited tax deduction under sec. 43D of the Income-tax Act. On the contrary, write-off as a bad debt can be fully claimed. Therefore, as back as in 2009, the RBI advised:
“Therefore, the banks should either make full provision as per the guidelines or write-off such advances and claim such tax benefits as are applicable, by evolving appropriate methodology in consultation with their auditors/tax consultants. Recoveries made in such accounts should be offered for tax purposes as per the rules.”
Similar paras appear in the Prudential circular of 2007 and 2008 too.
What is the genesis of the word “technical write-off”? Is it coming from global jurisdictions? It does not seem so. As per our research, the 2009 circular of the RBI (cited above) permitted banks to write off advances at HO level, even though they are outstanding at the branch level [this, in present day parlance would mean, write-off in books of account, though still outstanding in the customer’s MIS LAN).
The RBI stated:
“Banks may write-off advances at Head Office level, even though the relative advances are still outstanding in the branch books. However, it is necessary that provision is made as per the classification accorded to the respective accounts. In other words, if an advance is a loss asset, 100 percent provision will have to be made therefor.”
This write-off, done at HO level but not at branch level, has been referred to as prudential or technical write off, that is written-off technically, but not written-off really. In the forms appended to Master Circulars of 2011 onwards, the word “technical write off” appears with the meaning referring to advances which are written off at HO level.
FAQs on Write off
Below are some of the pertinent questions on write-offs:
Meaning and Concept
- As per Master Circular – Prudential Norms on Income Recognition, Asset Classification and Provisioning pertaining to Advances dated April 1, 2023 (‘Prudential Circular’), applicable upon Banks, there is a category of NPAs termed as “loss assets”. These assets are required to be fully written off. Likewise, the Framework for Compromise Settlements and Technical Write Offs (‘Technical Write-off Framework’) refers to “technical write off”. Is the write off of a loss asset, and the technical write off being discussed here the same thing?
Response:
Para 4.1.3 of the IRACP Circular defines a loss asset as follows:
“A loss asset is one where loss has been identified by the bank or internal or external auditors or the RBI inspection, but the amount has not been written off wholly. In other words, such an asset is considered uncollectible and of such little value that its continuance as a bankable asset is not warranted although there may be some salvage or recovery value.”
This loss asset has been placed as a category under NPAs.
The Technical Write-off Framework states:
“Technical write-off for this purpose shall refer to cases where the non-performing assets remain outstanding at borrowers’ loan account level, but are written-off (fully or partially) by the RE only for accounting purposes, without involving any waiver of claims against the borrower, and without prejudice to the recovery of the same.”
The Prudential Circular provides that loss assets are either to be written off, or to be fully provided for. On the other hand, the Compromise Framework clearly refers to full or partial write off.
The intent of the two is the same – to write down what is worthless. However, the Prudential Circular is referring to the degradation of an NPA – from substandard, to doubtful, to loss, where it comes to a stage where there is a trivial recovery value. The end result is the same – the first one is a mandatory prudential requirement; under the Technical Write-off Framework, accounting write-off is purely optional.
- Can a lender do a partial write off? Or write off means the entire amount due from the borrower needs to be written off?
Response:
Very clearly, the technical Write-Off Framework provides the option for a partial write-off. Further, in terms of para 5.4.4 of Ind As 109
“An entity shall directly reduce the gross carrying amount of a financial asset when the entity has no reasonable expectations of recovering a financial asset in its entirety or a portion thereof. A write-off constitutes a derecognition event [see paragraph B3.2.16(r)].“
Further, para B3.2.16(r) provides that,
“The following examples illustrate the application of the derecognition principles of this Standard- (r) Write-off. An entity has no reasonable expectations of recovering the contractual cash flows on a financial asset in its entirety or a portion thereof.“
Therefore, accounting norms also allow for partial write offs and to the extent the loan has been written off, the lender can derecognise the loan asset from their books.
- What is the approach towards write off? In case of secured loans, and in case of unsecured loans?
Response:
The key to determination of write-off is the extent of recovery in an impaired loan. That is, what is considered not recoverable is written off. So, the task is to recognise (a) an impaired loan; (b) make a fair estimate of recoverable amounts from the loan; (c) apply a suitable discounting factor; and thus, find the fair value of the loan. The difference between the POS and such fair value becomes the amount of the write-off.
In case of secured loans, the focus is on the value of the collateral, the haircut on its valuation due to sale of repossessed collateral, legal expenses and costs on recovery, the time taken, etc.
- What is the stage of write off – only when the asset turns an NPA or can the write off be done before it is recognised as NPA?
Response:
The Technical Write-off Framework refers to technical write off in case of NPAs. The IRACP Circular (applicable upon Banks) also refers to a loss asset as a sub-category of NPAs. However, under the SBR Directions (relevant for NBFCs), loss asset is not a sub-category of NPA but is defined as a separate asset class:
(i) an asset which has been identified as loss asset by the NBFC or its internal or external
auditor or by the Reserve Bank during the inspection of the applicable NBFC, to the extent it is not written off by the applicable NBFC; and
(ii) an asset which is adversely affected by a potential threat of non-recoverability due to
either erosion in the value of security or non-availability of security or due to any fraudulent act or omission on the part of the borrower.
That, however, does not imply that a lender cannot have a policy of recognition of impairment before an asset turns NPA. This will depend on the nature of the asset. For example, in case of personal loans, if a lender recognises a loan as impaired after 60 DPD, the lender may do a write off. Of course, there is no justification to do a write off if the loan is not considered impaired, on the basis of the parameters that may be applicable to the said loan.
- There are two facilities to a borrower – can one be written off while the other one continues? What will be the basis for the same?
Response:
Yes. It is possible that one loan is backed by a tangible collateral, say, home loan or gold loan, while the other loan is unsecured. While the borrower may default on the unsecured loan, he may be maintaining performance on the secured loan, in order not to lose the collateral. If the value of the collateral, on the basis of principles discussed above, is good, it is possible to conclude that no write-off is required in case of the secured loan, while write-off may be done in case of the unsecured one.
- If one facility to a borrower is written off, can the other continuing facility, which is not in default, be treated as performing/standard?
Response:
Even though one loan (having a DPD status of 90+ days) is written off, the borrower’s liability to pay and the lender’s right to recover continue. The borrower is a defaulter. NPA classification is based on borrower, and not on facility. Hence, the other facility will remain NPA.
- After write-off, can the lender give a fresh loan to the borrower?
Response:
We find it quite difficult to justify giving a fresh credit facility to a borrower who caused a write-off. However, para 12 of the Technical Write-off Framework allows giving of new loans to a borrower whose account has been written off after a minimum cooling period decided in accordance with the lender’s Board-approved policy.
- In case a borrower has been written off by a particular lender, can another lender extend a fresh loan to such borrower? Would the cooling period provision be applicable in such a scenario?
Response:
The response to this seems affirmative, as the language of the Technical Write-off Framework suggests that bar on taking fresh exposure during the cooling off period is on the RE involved in the arrangement, however, it does not suggest any prohibition on other lenders to take fresh exposure during this period.
Of course, other lenders will have to take their own informed credit call and carry out the credit assessment in view of the impaired credit history of the borrower.
- What is the difference between:
- write off and waiver
- Write off and restructuring
Response:
Waiver is the exhaustion of all rights to recoverability of the loan amount as compared to write offs where the lender writes off the amount only for accounting reasons but retains the legal right to recover money.
For difference between write off and restructuring, refer to our write up – A comprehensive framework for compromise settlement and technical write offs.
Policy and Approval Hierarchy
- What should be the contours of the write-off policy? If there is an SOP for write off, what will the SOP contain?
Response:
The write off policy must contain the following aspects:
- Condition precedent for write offs – this may include:
- Efforts taken for a one-time settlement;
- death of the borrower with absence of insurance;
- achievement of a certain number of days past due before writing off);
- Deterioration in the collateral value
- a stipulation that if the monthly recovery drops below a certain % of the loan outstanding only then will the loan be written-off;
- untraceability of borrower;
- absence of guarantor support;
- minimum time elapsed since last recovery;
- exhaustion of all possible legal remedies etc.
- Approval authority for the write-off – an approval matrix should be drawn for this purpose based on:
- Size
- Nature of loan
- DPD status
- Determining the write off amount – this will be based on the extent of security available, recovery efforts already taken, recovery costs associated etc.
- Reporting Mechanism for write offs – to the board and CICs
The SOP on the other hand should provide for the following:
- Recovery efforts taken and exhausted before arriving at the write off decision
- Determination process of the write off amount
- Recovery efforts to be taken after write off etc.
- Who should approve the write off?
Response:
The delegation of powers for approving write-offs should be clearly articulated in the Policy (Para 5 of Annex to the technical Write off Framework). To ensure objectivity and avoid any potential conflict of interest or a ‘judge in its own case’ scenario, the write-off should, as a general principle, be approved by an authority which is at least one-level higher than the sanctioning authority of the original exposure. The approving authority should be determined based on factors such as the size of the exposure/write-off, the nature and duration of the borrower relationship. The policy should provide adequate flexibility while maintaining robust checks and balances.
- What evidence of uncollectability is required to be put on record for write-off action?
Response:
The assessment will be borrower-specific. A detailed record of all the recovery actions taken, outcomes, and reasoned justification that all reasonable recovery measures have been exhausted, and further recovery is impractical, shall be maintained. This shall include reminders, follow-ups, legal notices, enforcement actions, and other efforts undertaken.
- An aggressive lending policy, backed by an aggressive write off policy – what implications does it have for the lender, or for the system? In a situation where the lender is witnessing high levels of write off, is there a need to revisit the lending policy ?
Response:
Lending has to be responsible, that is, lenders have to assess the prospects of recovering the loan in view of the borrowers’ cashflows. Lenders determine their lending spreads based on expected losses of the portfolio. Therefore, the cost of defaults is charged on the borrowers. Aggressive lending, in a way, involves the cost of the defaults being passed on to those who mean to pay. The assessment of the borrowers’ ability to pay is not merely an ex ante assessment – it is also benefited by the feedback from performance of the existing pools. Therefore, if a pool is having significant and excessive write off, lenders need to reexamine their lending practices.
Reporting
- When the lender writes off the loan, is the lender required to notify the same on the CIC portal?
Response:
Yes, as per the data formats laid down in Annex IV of Master Direction – Reserve Bank of India (Credit Information Reporting) Directions, 2025, a credit institution is required to report written-off amount (total and principal). When an account is reported as written-off and the borrower makes the complete payment, i.e., through settlement or otherwise, the ‘Credit Facility Status’ field in CIC reporting shall be reflected as ‘Post Write Off Closed’.
- How long will a lender be required to report write offs to CICs ?
Response:
It may be operationally challenging for lenders to report write-off cases indefinitely. However, considering that the idea of CIC reporting is borrower behaviour, the borrower continues to be a defaulter. Therefore, merely because a loan is written off in accounting books should not mean it should be taken off CIC records.
Accounting
- Is there accounting guidance on how the amount of write off/partial write off is to be computed?
Response:
As per Paragraph B5.4.9 of Ind AS 109,
“a financial asset, or a portion thereof, is required to be written off when there is no reasonable expectation of recovering the contractual cash flows. The standard allows for partial or full write-offs, depending on recoverability assessments. For example, if 30% is expected to be recovered via collateral and no further recovery is reasonably expected, then the remaining 70% is to be written off.”
However, Ind AS 109 does not prescribe a specific methodology for computing the amount to be written off, nor does it provide distinct guidance for unsecured lending. In such cases, since no collateral is involved, the amount can be determined based only on how much recovery is reasonably expected from the borrower. For this purpose, the lenders must have a SOP in place which will determine the write off amount based on the expectation of recovery, cost of recoveries, DPD status, borrower history etc.
- When an asset is written off, what happens to the specific provision made against the asset, which is outstanding?
Response:
When a loan is written off, the entire amount that is being written off is charged to P/L
When a loan is written-off, the gross carrying amount of the loan is reduced to zero. The specific provision already created against it is utilised (i.e. reversed) against the carrying amount. In other words, as the loan is written off, so is the specific provision against such loan.
- What is the impact of write off on the impairment for ECL?
Response:
A write off is a case of incurred loss, whereas ECL is made for expected loss. Expected loss should precede incurrence of the loss, since ECL is forward looking. Therefore, the extent of write off should force a lender to re-examine and calibrate the ECL estimation, such that a write off does not exceed the ECL against such assets..
- Is it justifiable to say that there was no SICR and the asset was written off?
Response:
Sans any Significant Increase in Credit Risk (SICR), a financial asset remains in Stage 1 under Ind AS 109. It is generally not prudent to write off a Stage 1 asset, as a write-off requires the lender to have no reasonable expectation of recovering the asset, in whole or in part, a condition that ordinarily implies the asset is credit-impaired and therefore classified under Stage 3. That said, as discussed in above, a write-off before an asset turns to NPA may still be possible, provided there is objective evidence of impairment based on the lender’s internal credit risk assessment, particularly in cases such as short-tenure personal loans or unsecured retail loans, where credit deterioration may manifest earlier than 90 DPD.
- What will be the accounting treatment for the recoveries received after an account has been written off?
Response:
Any amount received (principal or interest) after a loan account has been written off will be shown as income in the P/L.
Tax treatment
- What will be the tax treatment for write off in the books of the lender?
Response:
For Banks and NBFCs, the tax treatment of loan write-offs is primarily governed by Sections 36(1)(vii) of the Income Tax Act, 1961 (‘IT Act, 1961’). As per Section 36(1)(vii), these entities can claim a tax deduction for bad debts or parts thereof that are actually written off as irrecoverable during the financial year. There are conditions as evidence of the amount having been taken in computation of income, as also reference to accounting standards – ICDS – under sec. 145 (2).
In addition, deduction is allowed for provision, upto limits, under Section 36(1)(viia).
Hence, if there is a write off, the same is deductible against income. However, if the write off was preceded by a provision, and the entity has claimed the benefit of the provision u/s 36 (1) (viia), then the write off should be first adjusted against such provision.
Further, in terms of Section 43D of the Income tax Act, an amount which has already been written off and subsequently recovered will be chargeable to tax in the previous year in which it is credited by the lender to its P/L account or in the year it is actually received, whichever is earlier.
Other resources –
FAQs on Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans
– Team Finserv | finserv@vinodkothari.com
(Updated as on October 01, 2025)
On August 18, 2023, the RBI came up with a circular on Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans (‘Circular)[1] casting certain obligations and disclosure requirements on Regulated Entities (REs) at the time of reset of floating interest rate on EMI based Personal loans. Accordingly, this Circular shall be adhered to by all applicable entities at the time of reset of floating interest rate on such loans.
We have developed a set of FAQs on the Circular, where we intend to answer some of the critical questions relating to the actionables by the REs at the time of reset of floating rate.
Further, our detailed article on this topic can be read here – RBI streamlines floating rate reset for EMI-based personal loans
Applicability and Coverage
- Which entities are covered by the Circular?
The Circular covers
- All Scheduled Commercial Banks
- Regional Rural Banks
- Primary (Urban) Co-operative Banks
- State Co-operative Banks and District Central Co-operative Banks
- Non-Banking Financial Companies
- Housing finance Companies
- Which type of loans are covered by the Circular?
The Circular covers all EMI-based floating interest rate personal loans. Accordingly, business loans are not covered by the circular.
Further, if the loan carries a fixed rate of interest, it does not come under the Circular.
If the loan is not based on EMIs, that is, it is a bullet repayment loan, it does not seem to be covered by the Circular.
Further, the FAQ 1 of the RBI FAQs dated 10.01.2024 have clarified that the Circular is applicable only on EMI-based floating-rate personal loans.
Summarising the above, the table below states the applicability of the Circular on certain types of loans –
| Covered by the Circular | Not covered by the Circular |
| Home loans at floating rate of interest | Home loan at fixed rate of interest |
| LAP to individuals other than for business purposes | LAP given to an individual/sole proprietor |
| Auto loans having rate variation clause | Auto loans not having rate variation clause |
| Student loans having rate variation clause, whether with or without moratorium | Fixed rate student loans |
| Loans against shares | Financial leases |
- A loan is based on EMIs, but is currently under a moratorium. Will it be covered by the Circular?
Yes, in our view. The EMIs are subjected to either variation, or the term may be modified based on interest rate changes. Hence, the Circular applies.
- A loan is based on EMIs, but has a partial balloon repayment. Will it be covered by the Circular?
In our view, yes.
- My company follows a different approach to interest rate variation. Neither do we increase the EMI, nor do we extend or contract the maturity based on interest rate changes. Instead, we add the impact of interest rate changes to a terminal amount, which either goes up or comes down based on interest rate changes. In a way, the last “unequal installment” reflects all interest rate changes during the period. Are we covered by the Circular?
In our view, yes. The burden or benefit of interest rate changes is being passed on. The applicability of the Circular is not dependent on the way the burden or interest is being passed on, instead it shall cover all floating interest rate personal loans. Hence, the Circular does apply in the present case.
- What type of loans are covered under “personal loans”?
As clarified by FAQ 1 of the RBI FAQs dated 10.01.2024, for understanding the meaning of Personal loans reference shall be made to the RBI circular on XBRL Returns – Harmonization of Banking Statistics[2] which defines personal loans as-
“loans given to individuals and consist of (a) consumer credit, (b) education loan, (c) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), and (d) loans given for investment in financial assets (shares, debentures, etc.).”
Further, “Consumer Credit” has been again defined as-
“loans given to individuals, which consists of (a) loans for consumer durables, (b) credit card receivables, (c) auto loans (other than loans for commercial use), (d) personal loans secured by gold, gold jewellery, immovable property, fixed deposits (including FCNR(B)), shares and bonds, etc., (other than for business / commercial purposes), (e) personal loans to professionals (excluding loans for business purposes), and (f) loans given for other consumptions purposes (e.g., social ceremonies, etc.). However, it excludes (a) education loans, (b) loans given for creation/ enhancement of immovable assets (e.g., housing, etc.), (c) loans given for investment in financial assets (shares, debentures, etc.), and (d) consumption loans given to farmers under KCC. For risk weighting purposes under the Capital Adequacy Framework, the extant regulatory guidelines will be applicable.”
- Does the Circular cover Loans Against Property?
There is no end use restriction in case of Loan Against Property or LAP. In case the same is extended to an individual it may or may not be for personal use. In such a case, if it is given to individuals for purposes other than business then it will be covered by the Circular.
However, in case it has been extended to non-individuals, such as SMEs or small businesses, it can be presumed that the primary use of the loan proceeds shall be for business purposes and therefore it will not be covered by the Circular.
- Are we saying any lending to companies is outside the scope of the Circular?
Yes, in our view, the intent is to cover only personal loans to individuals- more specifically, EMI based floating rate personal loans. Since, it would be counter intuitive to say that the loan given to companies would be for personal use, the same may not be covered under the Circular.
- Are auto loans covered by the circular too ?
Yes, the definition of the term consumer credit includes auto loans as well and therefore the same will be covered by the circular. Accordingly, all auto loans having a rate variation clause are covered by the circular.
- Are loans given to SMEs covered?
As discussed previously, business loans are not covered by the Circular. Accordingly, SME loans do not fall within the ambit of this Circular.
- Does the circular extend to micro-finance loans as well?
Yes. Microfinance loans as defined in the RBI Master Direction for Microfinance Loans, 2022 states that all collateral-free loans, irrespective of end use and mode of application/ processing/ disbursal (either through physical or digital channels), provided to low-income households, i.e., households having annual income up to ₹3,00,000, shall be considered as microfinance loans.
Accordingly, the microfinance loans fall within the ambit of the Circular in case they are extended at a floating rate.
- Are digital loans covered by the Circular?
Yes, EMI based floating rate digital loans are also covered by the Circular.
- Whether the Circular covers both floating rate loans linked with external benchmark as well as internal benchmark rate?
Yes, as per RBI FAQ No. 6, all EPI-based floating rate personal loans, whether linked to an internal or external benchmark rate, are covered under the purview of this Circular.
Options with the borrower
- In case of reset in the floating interest rate, what are the options that have to be given to the borrower?
The Circular provides for a number of options which should be given to the borrower in the event of reset of the floating rate of interest. These are –
- Enhancement/ reduction in EMI
- Elongation/ contraction of tenor
- Combination of both options
- Prepayment in part
- Prepayment in full
- Switching from floating rate to fixed rate, which is optional for the lender to provide[3]
This has been further affirmed by FAQ No. 3 of RBI FAQ dated 10.01.2024.
- In case the borrower does not exercise any option then can the REs provide a default option?
Yes, REs may put in place a default option which will be automatically exercised in case the borrower does not communicate his choice to the lender within a reasonable time given to him. In most cases, this default option is an elongation of the loan tenor. Ideally, this default option should also be communicated to the borrowers.
- Let’s assume, the fixed interest rate at the time of sanctioning the loan was 14%. Now at the time of change in the floating rate of interest, the borrower exercises the option to convert his floating rate loan to a fixed interest rate loan. In such a case, are the REs required to charge the fixed rate of 14% or can they charge a higher rate ?
REs are not obligated to charge the same fixed rate of interest which was prevailing at the time of sanctioning of the loan.
- How many times can a switch from floating to fixed rate and vice versa take place during the tenor of the loan ?
While the Circular itself does not specify the number of times such a switch is allowed during the tenor of the loan it states that the board approved policy framed may specify the same, provided that the RE intends to offer such an option. Accordingly, the number of times such a switch may happen during the tenor of the loan will be governed by the respective policies of the REs.
- What is negative amortization?
Negative amortization refers to a situation where the scheduled payments on a loan are insufficient to cover the interest costs. As a result, the unpaid interest gets added to the loan’s principal balance. This leads to the loan balance increasing over time, rather than decreasing as it would with regular amortization.
- What is the external benchmark lending rate?
As per the RBI circular on External Benchmark Based Lending[4] the base rate of the floating interest rate loans should is benchmarked to any one of the following:
- Reserve Bank of India policy repo rate
- Government of India 3-Months Treasury Bill yield published by the Financial Benchmarks India Private Ltd (FBIL)
- Government of India 6-Months Treasury Bill yield published by the FBIL
- Any other benchmark market interest rate published by the FBIL.
The Circular covers all loans linked to an external benchmark rate and in case of any reset in the floating interest rate with respect to such loans, the Circular becomes applicable.
Prepayment Option
- Are we saying prepayment option has to be given to a borrower at every stage of a loan?
Usually the prepayment option is provided to the borrower, with or without certain caveats such as exercising the option post the initial lock-in period or levy of prepayment penalty, to the extent permissible, etc. The Circular provides to specifically provide this option at the time of reset of the floating interest rate. This option would be in addition to the prepayment option provided to the borrower as per the loan terms.
- Are we saying a partial prepayment option has to be given to the borrower at every stage of a loan? Can the lender fix a minimum partial prepayment size? How large can such partial prepayment size be?
As discussed above, the partial prepayment option at any time of the loan shall be as per the agreed loan terms, that is with minimum size etc. However, the option at the time of reset should not be restricted and the borrower shall be allowed to partially prepay at its discretion.
- What is the position about prepayment penalties?
The Circular states that in case the borrower exercises the option to prepay the loan either in full or in part, the prepayment penalty or foreclosure charges shall be in accordance with the extant guidelines.
However, levying prepayment penalty in case of floating interest rate loans to individuals for purposes other than business is not allowed both under the RBI Master Direction for NBFCs as well as RBI Master Directions for HFCs.
- Can there be a penalty for partial prepayment?
While the situation for charging prepayment penalties remains the same in case of partial prepayment too, as discussed above, charging of such penalties in case of floating interest rate loans to individual borrowers for purposes other than business is not permitted.
- Can the lender establish conditions for foreclosure, such as mandating that foreclosures can only occur in a single instance?
RBI in the circular has recognised partial foreclosure and specified the same as an option to be provided at the time of reset of the floating rate. Therefore, the lender at the time of reset in the floating rate of interest, has to give the borrower an option to either foreclose the loan in part or in full.
However, in other cases, the lender may impose conditions such as the one mentioned in the question. .
- Can the lender impose a restriction on the number of partial prepayments during a year?
Considering the operational hassle and to discourage borrowers from frequently exercising the prepayment option, there can be restrictions imposed on the number of partial prepayments during a year. The same must be specified clearly in the loan documentation.
- Can the excess amount paid by the borrower at the time of foreclosure be forfeited by the lender?
Foreclosure should not be declined due to payment of excess amount.
However, receipt of excess amounts could lead to operational hassles for the lenders, therefore, to discourage the customers for paying excess amounts and claiming refunds, the lender may incorporate a condition in the loan agreement stating that in case the company receives an excess amount at the time of foreclosure of loan, it shall refund the excess amount after deducting the administrative charges.
- Can the lender allow foreclosure of the loan only between a specific period of the month, say between 10th to 20th of a month?
Yes, the same can be done for operational purposes. The lender should clearly specify the same in the loan documentation.
- The HFC directions provide that no foreclosure charges can be charged to the borrowers who are closing the loan through their own sources. In this regard can the lender ask for documents to determine the borrowers’ capacity to pay at the time of pre-closure?
First and foremost, the onus to prove that the prepayment is being done out of owned funds will be on the borrower. However, in order to satisfy itself, the lender may ask for documents evidencing the borrower’s capacity to pay out of its own funds. In this regard, the lender may ask for documents like 2-3 months’ bank statements or other documents which can prove the borrower’s capacity to pay.
- Can the lender impose a condition restricting part-payment and foreclosure for an initial period of 12 months?
In case of a reset in the floating rate of interest such a condition cannot be imposed and the lender has to allow foreclosure of the loan even during the initial period of 12 months.
In other cases, however, the lender may specify an initial period during which prepayment of loans shall not be allowed.
- In case of partial prepayment, does the borrower have the option of (a) reducing EMIs every month, keeping the tenure the same, or (b) contracting the tenure?
In our view, EMIs are fixed based on the affordability and the debt-to-income ratio of the borrower. If the loan size gets curtailed due to partial prepayment, reducing the EMIs seems an unreasonable requ. We are of the view that if the lender does not agree to reducing the EMIs, and gives effect of the reduced principal on the remaining term, the same is reasonable.
Fixed rate option
- Are we saying a fixed rate option has to be given to the borrower at every stage of the loan, or is it only at the time of a variation of interest rates?
Response:
Fixed rate options do not have to be mandatorily offered to the borrower as per the RBI (Interest Rate on Advances) (Amendment Directions), 2025[5]. However, if the lender still wishes to offer a fixed rate loan product at the time of variation, they must parallelly offer a floating and an equivalent fixed rate option.
- Are we expecting a lender to disclose to the borrower what the fixed rate will be, in case of a variation of interest rates?
This is counter-intuitive. The fixed rate at the time of interest variation will be the fixed rate that corresponds to the revised variable rate at the time of variation.
- How does one arrive at a fixed rate corresponding to a floating rate loan?
The pricing of a fixed rate loan factors the interest rate variation risk, as the only differentiator between a floating rate loan and fixed rate loan is the interest rate risk. In the case of a floating rate loan, the risk is transmitted to the borrower; in case of a fixed rate loan, the risk is taken by the lender. Hence, the lender has to price the interest rate variation risk.
The approach may be the same as the cost of an interest rate swap (IRS), that is, the fixed rate cashflows for a floating rate loan. There is a significant difference between an IRS and the pricing of a fixed rate loan. In the IRS, the notional value remains the same all through; in case of a home loan, the POS continues to amortize. However, that difference may not matter, as the rates are applied in either case on the notional value/ POS value. The other difference is the ability to prepay the loan which does not exist in case of an IRS. These nuances apart, the pricing may follow the same underlying logic.
In practice most home lenders price a fixed rate loan at the higher end of the yield curve for the remaining term of the loan. The slope of the yield curve captures the potential future changes in interest rates.
A borrower switching from a floating rate to a fixed rate loan protects himself from further changes; at the same time, deprives himself of the benefit of any rate reduction thereafter.
26A. Can a lender provide an option to a borrower to switch from floating to fixed and vice versa, and if yes, then how fixed rate can be switched into floating rate.
The position of a fixed rate loan getting converted into a floating rate loan is the same as that of prepayment of a fixed rate loan. When a fixed rate loan is prepaid, the lender loses the fixed rate of interest, and assuming that the money will now get invested at the-then prevailing rate, the lender will earn at the prevailing rate. When a fixed rate loan is swapped against a floating rate, even though there is no prepayment, the position is similar. As in the case of prepayment, the borrower will do the switchover only where he expects the interest rates to come down.
Fixed rate loans carry a mark-to-market gain when interest rates have moved down (the gain is not brought into books at loans are mostly carried at amortised cost, except where they fail the “business model of holding the loans” test. As floating rates are repriced based on market rates, they cannot carry any mark-to-market gains, except for the difference between the underlying base rate, or the credit risk premium.
The relationship between fixed rate and floating rate at any time is driven by the slope of the yield curve. If the yield curve is showing a downward slope, it is quite logical that the fixed rate option is cheaper than the floating rate. That itself will be a disincentive for the borrower to move from fixed rate to floating rate. In addition, the lender may charge a penalty (switchover charge) for choosing to move to floating rate, and this switchover charge may be priced based on the mark-to-market gain lost by the lender.
26B. If fixed rate is allowed to switch into floating then can the lender charge switching fees? How will the same be computed?
Para 2(iv) of the circular states that “all applicable charges for switching of loans from floating to fixed rate and any other service charges/ administrative costs incidental to the exercise of the above options shall be transparently disclosed in the sanction letter and also at the time of revision of such charges/ costs by the REs from time to time.“
In our view, what can transparently be disclosed is the computation of the switchover charges, as the actual charge is based on the mark-to-market gain inherent in the fixed rate loan at the relevant time.
According to RBI FAQ No. 7, the RBI has clarified that the switching charges, as approved by the Board of RE, should be displayed on the website. Therefore, the applicable switching charges may be updated periodically on the website to ensure transparency for customers.
Board-approved Policy
- The REs are advised to put in place a board approved policy for the reset of floating interest rate on EMI based personal loans. What will be the contents of this policy ?
The policy should at minimum cover the following –
- Options to extend to customers;
- Maximum allowable frequency for borrowers to switch between floating and fixed rate loans;
- Applicable charges related to the provided borrower options.
Disclosure and Communication
- Are the REs required to send a statement to the borrowers every quarter ?
The Circular states that REs shall share / make accessible to the borrowers, through appropriate channels, a statement at the end of each quarter.
Accordingly, if the borrowers have access to this quarterly statement, the same is in sufficient compliance with the provisions of the Circular and there is no requirement of sending such statements to the borrower every quarter.
- What are the contents of this quarterly statement ?
The quarterly statement should at the minimum state –
- Principal and interest recovered till date
- EMI amount
- Number of EMIs remaining
- Annualized rate of interest / Annual Percentage Rate (APR) for the entire tenor of the loan.
- Are there any other disclosures required to be made to the borrowers apart from the quarterly statement?
Yes, at the time of sanction of loan APR and possible impact of change in benchmark rate of interest shall be disclosed in the KFS. Further, whenever there is any change in benchmark rate the same shall be communicated to the borrowers.
This has been clarified vide FAQ No. 2 of RBI FAQs dated 10.01.2024.
- In case of loans other than floating interest rate loans, is there a requirement to send/make accessible such a statement every quarter to the borrowers ?
The Circular extends to only EMI based floating interest rate personal loans. Therefore, this requirement of sending/making accessible a quarterly statement to the borrower does not extend to other types of loans. The same would be sent as per the internal policy of the lender.
- The Circular is applicable from 31st December 2023. Are the REs required to intimate the borrowers of the various options available to them in the event of change in the floating rate of interest before such date ?
The Circular covers both existing and new loans. Accordingly, all applicable entities are required to intimate the borrowers on or before 31st December 2023, the options available to them in the event of reset of floating interest rate.
This has been further affirmed by FAQ No. 9 of RBI FAQs dated 10.01.2024.
[1] Reserve Bank of India – Notifications (rbi.org.in)
[2] Reserve Bank of India – Notifications (rbi.org.in)
[3] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12902&Mode=0
[4] Reserve Bank of India – Notifications (rbi.org.in)
[5] https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=12902&Mode=0
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