RBI Mandates Flexible Options for Personal Loan Borrowers

August 19, 2023

The Reserve Bank of India (RBI) has directed regulated entities, including banks and NBFCs, to provide personal loan borrowers the flexibility to switch from floating to fixed rate interest regimes at the time of interest rate resets. In a circular, the RBI also stated that borrowers must be offered the choice to increase Equated Monthly Installments (EMIs) or extend the loan tenure. Lenders are required to transparently communicate the potential impact of benchmark interest rate changes on EMIs and tenor during loan sanction.

The circular emphasizes that any EMI or tenor changes must be promptly conveyed to borrowers. The RBI aims to curb undue elongation of loan tenors without consent, improve communication, and prevent negative amortization. The directive should apply to both existing and new loans by December 31, 2023.

What does the RBI’s circular require of regulated entities regarding personal loans?

The RBI’s circular mandates banks and NBFCs to offer personal loan borrowers the choice to transition from floating to fixed interest rates during interest rate resets. Borrowers should also have the option to increase EMIs or prolong the loan tenure.

Why did the RBI introduce these new regulations?

Instances of lenders elongating loan tenors without proper consent or communication have prompted the RBI to intervene. Arbitrary EMI changes and unnotified tenor extensions have been reported, causing borrower discontent and concerns about monetary transmission.

How can floating rate loans be reset?

Floating rate loans’ interest rates can be reset by banks through modifications in their internal benchmark rates and spreads. The RBI’s directive aims to prevent abrupt changes that might harm borrowers’ interests and hinder monetary transmission.

How does the RBI address unduly long elongation of loan tenors?

The RBI’s directive aims to prevent banks from excessively extending loan tenors without proper communication. Such elongation could mask financial stress and negatively impact borrowers, trapping them with higher charges.

What are the challenges borrowers face when considering refinancing?

Theoretically, borrowers could refinance by switching to another bank. However, differences in internal benchmarks and reset practices make this option impractical. Borrowers often find themselves with limited choices, leading to paying higher charges on existing loans.

What constitutes personal loans as per the RBI?

Personal loans encompass various categories such as consumer credit, education loans, loans for immovable asset creation or enhancement (like housing loans), and loans for investing in financial assets (stocks, debentures). As of June 2023, personal loans accounted for nearly 30% of non-food bank credit.

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