Penal Charges on Loans: RBI Rules That Replaced Penal Interest, With Examples and a Checklist

Miss an EMI and two things can happen: the lender charges you for the default, and the missed amount keeps earning interest. Until 2024 many lenders did the first part by adding “penal interest” of 2% a year or more on top of your loan rate. RBI ended that. Since 1 January 2024, lenders can only levy penal charges, a fixed or reasonable fee that cannot be compounded. Here is what the rules say, how they work in practice, and what to do if you think you were overcharged.

What penal charges are, and what they replaced

RBI’s circular “Fair Lending Practice – Penal Charges in Loan Accounts”, dated 18 August 2023, starts from a simple principle: penalties exist “to inculcate a sense of credit discipline” and “are not meant to be used as a revenue enhancement tool over and above the contracted rate of interest”. RBI found that lenders were using penal interest in divergent ways, which led to complaints and disputes.

The eight rules in RBI’s penal charges circular

1. Charges, not interest. Penalty for non-compliance with material terms of the loan “shall be treated as ‘penal charges’ and shall not be levied in the form of ‘penal interest’ that is added to the rate of interest”.
2. No capitalisation. No further interest is computed on penal charges. Normal compounding of loan interest is not affected.
3. No hidden add-ons. Lenders must not introduce any additional component to the interest rate.
4. Board-approved policy. Each lender must have a board-approved policy on penal or similar charges, by whatever name.
5. Reasonable and non-discriminatory. The amount must be commensurate with the breach and not discriminatory within a loan or product category.
6. Individuals protected. For individuals borrowing for non-business purposes, penal charges cannot be higher than those for non-individual borrowers for similar breaches.
7. Disclosed upfront. The amount and reason must be in the loan agreement, the most important terms and conditions or Key Fact Statement, and on the lender’s website under interest rates and service charges.
8. Told when charged. Reminders for non-compliance must state the applicable penal charges, and every levy and its reason must be communicated.

The rules apply to commercial banks (including small finance banks, local area banks and regional rural banks), urban co-operative banks, NBFCs including housing finance companies, and all-India financial institutions such as NABARD and SIDBI. Payments banks are excluded because they do not lend.

What is not covered

RBI’s penal charges circular does not apply to credit cards, external commercial borrowings, trade credits and structured obligations, which have their own product rules. Credit card late fees are governed by RBI’s card directions instead; our credit card billing cycle guide explains how those work.

Worked example: what changed for a missed EMI

Take a personal loan with ₹8 lakh outstanding and an EMI of ₹22,000, and say you miss one EMI and pay it 30 days late. The figures are our illustration.

The point is not that the new charges are cheaper in every case. A flat charge can cost more than penal interest on a small overdue amount. What changed is that the charge must be disclosed in advance, be reasonable for the breach, and not grow by compounding. If ₹1,315 of penal interest had been capitalised into a loan at 11%, it would have added about ₹145 a year in interest on top; that can no longer happen.

You still pay normal interest on the overdue EMI itself at the loan rate, because the money remains unpaid. That is interest under the loan contract, not a penalty.

What counts as a “material term”

The circular does not list them; each lender’s policy and your loan agreement do. Common examples include:

• missing or delaying an EMI;
• a bounced NACH mandate or cheque for the EMI;
• not renewing property insurance on a home loan where the agreement requires it;
• not submitting stock statements or financials on a business loan;
• breaching a covenant, such as using the loan for a purpose not allowed.

Check the KFS. If a charge is not listed there or on the lender’s website, ask why it is being levied. Our KFS explainer shows where to find it.

Bounce charges and penal charges together

When an EMI mandate fails, many lenders levy a “bounce” or “dishonour” charge as well as a late payment charge. Both are penalties by another name, and the circular says the board policy must cover “penal charges or similar charges on loans, by whatever name called”. So both must be reasonable, disclosed and communicated. Your own bank may also charge you for the failed debit on your savings account; that is a separate service charge.

How it affects your credit score

The penal charges rules do not change credit reporting. A missed EMI is still reported to credit bureaus, and an overdue loan moves through special mention account (SMA) stages as the days overdue increase. Our SMA and NPA guide explains the stages. Paying quickly matters more than the size of the penal charge.

Checklist: are you being charged correctly?

1. Find the penal charges in your sanction letter, loan agreement or KFS.
2. Compare with the lender’s website schedule of charges.
3. Look at your loan statement. Is the charge shown as a separate line, or has your interest rate gone up? A rate increase for a default is not allowed.
4. Check whether interest has been charged on the penal charge itself. It should not be.
5. Check that you were told of the charge and the reason when it was levied.
6. For an individual non-business loan, ask whether the charge is higher than for a company borrower; it should not be.

If you borrow for a business

The extra protection in rule 6 applies to individuals borrowing “for purposes other than business”. If you are a shopkeeper or professional taking a business loan in your own name, the lender can treat you like other business borrowers for penal charges, though the rest of the rules still apply: no penal interest, no capitalisation, reasonable amounts, upfront disclosure and communication when charged.

Business loans also tend to have more material terms, such as stock statements, insurance and financial covenants, so read the list of charges in the sanction letter carefully before signing.

Older loans

For loans taken before 1 January 2024, RBI required lenders to move to the new regime at the next review or renewal date, or within six months of the circular’s effective date, whichever was earlier. In practice that means all existing loans should have moved by 30 June 2024. If your statement still shows a higher “penal rate” applied for default, raise it.

How to complain

Write to the lender’s grievance redressal officer with your loan number, the date and amount of the charge, and why you think it breaks the rules. Ask for a reversal in writing. If there is no reply in 30 days, or you are not satisfied, file a complaint with the RBI Ombudsman under the Integrated Ombudsman Scheme; our guide walks through it. Keep screenshots of statements and messages.

If you are struggling with EMIs, talk to the lender before you default. Many lenders will restructure the EMI or extend tenure rather than keep levying charges; our loan default guide covers your options.

FAQs

Can a bank still charge penal interest on loans?

No. Since 1 January 2024, penalties for breaching loan terms must be penal charges, not penal interest added to the loan rate.

Can interest be charged on penal charges?

No. RBI’s circular bans capitalisation of penal charges.

Do these rules cover credit cards?

No. Credit cards are excluded and follow RBI’s separate card directions.

Is there a maximum penal charge?

RBI has not set a rupee cap. Charges must be reasonable, proportionate, board-approved and disclosed in advance.

Takeaway: Penal charges on loans must be a disclosed, reasonable fee, never extra interest, and never compounded. Check your KFS and loan statement after any missed EMI, and complain to the lender and then the RBI Ombudsman if the rules were not followed.