The Reserve Bank of India has asked lenders to clearly communicate to borrowers the possible impact of a change in the benchmark interest rate on personal loans, leading to changes in EMI (equated monthly instalment) and/ or tenor or both at the time of sanction.

It also directed them to provide borrowers the option to switch over to a fixed rate during reset of interest rates.

These directions are part of RBI’s circular to lenders (banks and non-banking finance companies, including housing finance companies) on ‘Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans’. 

Personal loans are 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.).

RBI asked REs to ensure that the instructions contained in the circular are extended to existing as well as new loans, suitably by December 31, 2023. Further, all existing borrowers should be sent a communication, through appropriate channels, intimating the options available to them.

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At the time of sanction, RBI said REs should clearly communicate to borrowers about the possible impact of change in benchmark interest rate on the loan, leading to changes in EMI and/or tenor or both.

Subsequently, any increase in the EMI/ tenor or both on account of the above should be communicated to the borrower immediately through appropriate channels.

Option to switch over to fixed rate

At the time of the reset of interest rates, lenders are required to provide borrowers the option to switch over to a fixed rate in line with their policy. The policy, inter alia, may also specify the number of times a borrower will be allowed to switch during the tenor of the loan.

“While personal loan borrowers will get the benefit of switching from floating to fixed-rate loans and vice versa, the RBI has allowed banks to cap the number of times this can be done.

“If there is no cap, borrowers will switch to a fixed-rate loan in a rising interest rate regime and to a floating-rate loan in a declining interest rate regime. The cap will ensure that Banks are not affected by such switches and monetary policy transmission is not impeded,” said a senior private sector bank official.

The central bank said the borrowers should also be given the choice to opt for (i) enhancement in EMI or elongation of tenor or for a combination of both options; and (ii) to prepay, either in part or in full, at any point during the tenor of the loan.

The levy of foreclosure charges or pre-payment penalties will be subject to extant instructions.

RBI said all applicable charges for switching loans from floating to fixed rates and any other service charges or administrative costs incidental to the exercise of the above options should be transparently disclosed in the sanction letter and also at the time of revision of such charges or costs by the REs from time to time.

Lenders have been asked to ensure that the elongation of the tenor in the case of a floating-rate loan does not result in negative amortisation. Negative amortisation allows a borrower to make a payment less than the standard installment set by the bank. This, in turn, leads to deferred interest instances.

Quarterly statement

RBI asked lenders to share or make accessible to borrowers, through appropriate channels, a statement at the end of each quarter that should, at a minimum, enumerate the principal and interest recovered till date, the EMI amount, the number of EMIs left, and the annualised rate of interest or Annual Percentage Rate (APR) for the entire tenor of the loan.

The lenders have to ensure that the statements are simple and easily understood by the borrower.

Apart from the equated monthly installment loans, the RBI said its instructions would also apply, mutatis mutandis, to all equated installment-based loans of different periodicities.

In the case of loans linked to an external benchmark under the External Benchmark Lending Rate (EBLR) regime, the banks should follow extant instructions and also put in place adequate information systems to monitor the transmission of changes in the benchmark rate to the lending rate.

RBI observed that at the time of sanction of EMI-based floating rate personal loans, REs should take into account the repayment capacity of borrowers to ensure that adequate headroom or margin is available for elongation of tenor and/or increase in EMI in case of a possible increase in the external benchmark rate during the tenor of the loan.

However, in respect of EMI-based floating rate personal loans, in the wake of rising interest rates, several consumer grievances related to the elongation of loan tenor and/or increase in EMI amount without proper communication with and/or consent of the borrowers have been received.

In order to address these concerns, the REs should put in place an appropriate policy framework as prescribed in the circular.

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