RBI Strengthens Borrower Protection Measures

Recently, the Reserve Bank of India (RBI) has identified unfair practices by banks that are leading to overcharging of interest on loans.

Charging Interest from Date of Sanction: Some banks were found charging interest from the date of loan sanction or execution of the loan agreement rather than from the actual disbursement date.
Interest on Disbursed Cheques: In cases where loans were disbursed by cheque, interest was charged from the date of the cheque issuance, not from the date when the cheque was encashed by the customer.
Incorrect Interest Calculation: Banks were observed charging interest for the entire month in cases of disbursal or repayment instead of only for the period when the loan was outstanding.
Collecting Advanced Instalments: Banks collect one or more instalments in advance, considering the entire loan amount for charging interest.

The RBI has instructed banks to distribute loan funds digitally rather than issuing cheques.
RBI directed banks and NBFCs to review their practices related to loan disbursal, interest application, and other charges.
Corrective actions, including system-level changes, are mandated to address the highlighted issues, ensuring fairness and transparency.

RBI’s Fair Practices Code guidelines, issued in 2003, emphasize fairness and transparency in interest charged by the lenders.
RBI views non-standard practices of charging interest unfavourably, as they deviate from the principles of fairness and transparency.

Introduction of Key Fact Statement (KFS): Banks must issue KFS to borrowers in simple language, providing standardised information about loans, including interest rates, EMIs, and charges.
Borrowers are required to acknowledge understanding of the loan proposal via KFS.
Effective from October 1, 2024, for all fresh retail and MSME loans.

Banks are required to inform borrowers clearly about the impact of changes in benchmark interest rates on their loans, including adjustments in EMIs and/or tenure.
Borrowers should be notified immediately about any increase in EMIs or tenure due to interest rate changes.
Borrowers should also be provided with the option to switch to a fixed interest rate, as per the institution’s policy.

RBI’s Role in Regulating Interest Rates

The Reserve Bank of India (RBI) plays a critical role in regulating interest rates in India.

One of RBI’s key objectives is maintaining price stability while promoting economic growth.
It achieves this through monetary policy tools, primarily by influencing short-term interest rates.

Repo Rate: The rate at which RBI lends short-term money to commercial banks.
Reverse Repo Rate: The rate at which RBI borrows short-term money from commercial banks.
Open Market Operations (OMO): RBI buys or sells government securities to influence liquidity and indirectly impact interest rates.
Cash Reserve Ratio (CRR): The portion of bank deposits that banks must maintain with RBI as reserves.
Statutory Liquidity Ratio (SLR): The portion of bank deposits that banks must invest in government securities.

Changes in the repo rate influence the cost of funds for banks.
Banks typically adjust their lending rates (prime lending rate, base rate, etc.) based on the repo rate.
Lower repo rates encourage banks to lend at lower rates, stimulating economic activity.
Higher repo rates discourage borrowing and control inflation by reducing money supply.