Penal Charges on Loans: RBI Rules and Loan System Changes
Penal Charges on Loans: Reconfiguring Loan Systems for RBI's Penal Interest Ban
Last reviewed: November 2026
Penal charges on loans are fixed charges a lender may levy when a borrower breaches material loan terms, and RBI rules bar lenders from taking that penalty as extra interest. The charge must be reasonable, disclosed upfront and never capitalised.
This guide is for CFOs, Chief Compliance Officers and CTOs at NBFCs and fintech lenders. It explains the rules as they now stand and the exact changes your loan, collections and communication systems need.
Key Takeaways
- For NBFCs, the rules sit in paragraph 30 of the NBFC Responsible Business Conduct Directions, 2025, which replaced the August 2023 circular.
- Penalties must be penal charges, not penal interest, with no capitalisation and no penal charge on penal charges.
- Default penalties apply only to the amount in default, under a board-approved policy.
- Amounts and reasons must appear in the agreement, KFS and website, and every levy must be communicated.
What Did the RBI Change?
The RBI stopped lenders from using penalties as a hidden rate increase. Its August 2023 circular on penal charges applied to fresh loans from 1 April 2024, with existing loans moved over by 30 June 2024.
On 28 November 2025, those instructions were folded into the RBI's entity-wise consolidated directions. Banks and other lenders have equivalent provisions in their own directions, so check clause numbers for your licence.
| Point | Old Practice | Current Rule |
|---|---|---|
| Form of penalty | Penal interest added to the loan rate | Penal charge as a separate amount |
| Base | Often the full outstanding | Only the amount in default |
| Capitalisation | Penalty added to principal and earning interest | Prohibited |
| Penalty on penalty | Common in practice | Prohibited |
| Amount | Set by product teams | Board-approved policy, reasonable and proportionate |
| Disclosure | Website schedule of charges | Agreement, KFS, website, reminders and each levy |
The rules exclude credit cards, external commercial borrowings, trade credits and structured obligations covered by product-specific directions. Everything else is in scope.
Why Did the RBI Step In?
The RBI observed that some lenders were using penal interest to raise revenue above the contracted rate. That practice drove complaints and disputes, and the consolidated directions still note that complaints often concern high interest and penal charges.
The intent is to make the penalty a deterrent for breaching terms, not a profit line. Your board policy and pricing reviews should be able to show that intent.
Which Rules Must Your Systems Enforce?
Each rule becomes a configuration or a block in the loan system. These are the ones with direct system impact.
- No rate add-ons. No additional component can be introduced into the rate of interest.
- Material terms from policy. Each lender's credit policy defines which breaches are material, and these can vary by loan category.
- Default base. Penalties for default apply only to the amount in default, and must be applied without discrimination.
- No compounding of penalties. Penal charges are not capitalised, and new penal charges cannot be levied on earlier ones.
- Contracted interest continues. Normal interest compounding is unaffected, and overdue interest or instalments can attract interest at the contracted rate.
- Borrower parity. Charges for individuals borrowing for non-business purposes cannot exceed those for non-individuals for similar breaches.
The RBI prescribes no cap. It says plainly that penal charges must not be used as a revenue enhancement tool.
How Should Loan Systems Be Reconfigured?
The change touches more modules than the fee engine. This table maps the work.
| Module | Required Behaviour |
|---|---|
| Product configuration | Rate fields hold only benchmark, spread and contracted rate, with no penal rate field |
| Charge engine | Penal charge head computed on the amount in default, from board-approved tables |
| Accrual engine | Interest never accrues on penal charge balances |
| Appropriation logic | Penal charges tracked as a separate bucket from principal and interest |
| Collections | Reminders show the applicable penal charge before it is levied |
| Notices | Each levy triggers a message stating the amount and reason |
| General ledger | Penal charges booked as a separate charge head with the correct tax code |
| Disclosures | KFS, agreement summary box and website populated from the same charge tables |
The safest design keeps one charge table as the source for computation, KFS text and website content. When the board changes a charge, every channel updates together.
What Should the Board Policy Contain?
The policy is the reference every system rule traces back to. It should be specific enough to configure without interpretation.
- Material terms by product, such as missed instalments, insurance lapses or covenant breaches.
- Charge amount or formula, with the base defined as the amount in default.
- Proportionality rationale, showing why each amount fits the breach.
- Parity check between individual non-business borrowers and non-individual borrowers.
- Waiver authority, with limits and reason codes.
- Review cycle, with the owner and date of the next review.
How Do You Test a Legacy Book?
Run four queries across the live book. Look for any loan with a penal rate after 30 June 2024, penal balances accruing interest, charges computed on total outstanding and levies with no matching borrower notice.
Every hit needs a root cause and a decision on remediation. Record both, because supervisors will ask how the gap was found and closed.
Charge leakage cuts both ways. A billing leakage detection agent can find charges levied outside policy, as well as charges the system failed to apply.
Does your loan system still have a penal rate field somewhere in a product setup?
Talk to Our Lending Technology Specialists
Visit Digiqt to see how we build loan systems with configurable, policy-driven charges.
How Does the Calculation Change?
The base and the form of the penalty change the borrower's cost sharply. In this illustrative case, a borrower with ₹8,00,000 outstanding at 14% misses a ₹25,000 EMI and pays 20 days late.
Old penal interest model (now prohibited). A 2% a year penal rate on the full outstanding for 20 days costs ₹8,00,000 × 2% × 20 ÷ 365 = about ₹877.
If unpaid, that amount would be capitalised and start earning interest. Both steps are now banned.
Current model. Suppose the board-approved policy sets a penal charge of 2% of the amount in default. The charge is ₹25,000 × 2% = ₹500, levied once and held in a separate bucket that earns no interest.
Contracted interest still runs as normal on the loan at 14%. That is the agreed price of credit, not a penalty, so it sits outside the penal charge rules.
What happens next month. If the borrower misses another EMI, the new charge is again 2% of that defaulted EMI, or ₹500. Nothing is charged on the earlier ₹500 penal charge.
Now see why the base matters. The same 2% applied to the full outstanding would be ₹8,00,000 × 2% = ₹16,000, which breaches the amount-in-default rule.
The lesson for leadership: most breaches come from the base, not the rate. Test every product's charge logic against worked cases before go-live.
How Must Penal Charges Be Disclosed and Communicated?
Disclosure runs from sanction to every levy. Each step needs system support.
- Upfront. Amount and reason in the loan agreement and the KFS or most important terms, with late repayment penalties in bold in the agreement.
- Website. Displayed on the lender's website, though a website reference alone does not meet the rule.
- Reminders. Every reminder for non-compliance states the applicable penal charge.
- Each levy. Every instance of a penal charge is communicated with its reason.
- Evidence. Delivery records for every reminder and levy notice, kept with the loan file for audit and complaint handling.
For digital loans, the multi-lender offer screen must show penal charges alongside APR, amount and tenor. Repayment nudges help too, and our article on AI for loan repayment shows how reminders can reduce defaults before charges arise.
Which Penal Charge Mistakes Do Lenders Make?
These errors recur across product lines.
- Legacy fields. A penal rate parameter left in an old product quietly adds interest.
- Wrong base. Charges computed on the total outstanding rather than the defaulted amount.
- Silent levies. Charges posted without a notice stating amount and reason.
- Inconsistent waivers. Ad hoc waivers break the non-discrimination principle within a product.
A fee waiver decisioning agent can apply waiver policy consistently, and a complaints and regulatory reporting agent can spot charge-related complaint patterns early.
What Else Is Changing Around Loan Charges?
Charge rules keep tightening at the edges. For floating-rate loans sanctioned or renewed from 1 January 2026, pre-payment charges are barred on loans to individuals for non-business purposes, and limited for business loans to individuals and MSEs.
Microfinance loans carry their own rule: delayed payment charges apply only to the overdue amount, not the whole loan. Both sit in the same consolidated directions as penal charges.
Want charge rules, disclosures and notices driven by one policy table?
Talk to Our Lending Technology Specialists
Visit Digiqt to see how we build lending platforms and loan servicing systems for NBFCs and fintechs.
