By S&S Co. Advocates & Solicitors · Published 27 August 2026 · Informational content, not legal advice: see our disclaimer
From 'Penal Interest' to 'Penal Charges'
The Reserve Bank of India's circular on Fair Lending Practice: Penal Charges in Loan Accounts fundamentally changed how lenders may charge borrowers for default or non-compliance with loan terms. Previously, many lenders levied additional 'penal interest' that was added to the applicable interest rate and compounded along with it. Under the revised framework, any such charge must be levied as a 'penal charge', a separate, one-time charge, rather than as additional interest, and critically, penal charges cannot be compounded; interest cannot be charged on penal charges.
What the Framework Requires of Lenders
Lenders must ensure penal charges are reasonable and commensurate with the specific default, without being used as a general revenue-enhancement tool, and must clearly disclose the quantum and rationale for penal charges in the loan agreement and the Key Facts Statement provided to the borrower. The same penal charge structure applicable to a given category of loan must be applied non-discriminatorily within that category: lenders cannot selectively impose harsher penal charges on individual borrowers within the same loan category without a disclosed, rational basis.
What Doesn't Count as a Penal Charge
Not every additional payment a borrower makes on default is a 'penal charge' in the regulatory sense: the framework specifically addresses charges levied for default or non-compliance with material loan terms, and does not restrict a lender's freedom to charge differentiated interest rates based on the borrower's credit risk profile at the time of sanction, which remains a matter of ordinary commercial pricing rather than a post-default penal charge.
What a Borrower Can Do
A borrower who believes a lender is charging compounded 'penal interest' dressed up as a fee, or imposing penal charges disproportionate to the actual default, can first raise the issue through the lender's internal grievance redressal mechanism, referencing the specific RBI circular, and if unresolved, escalate to the RBI Integrated Ombudsman Scheme, which has jurisdiction over deficiencies in service by RBI-regulated entities including non-compliance with fair lending directions of this kind.
Frequently Asked Questions
Can a bank still charge extra for a missed EMI payment?
Yes: lenders can still levy penal charges for default or non-compliance with loan terms, but under RBI's framework these must be reasonable, commensurate with the default, clearly disclosed, and cannot be compounded or charged as additional interest.
Is there a cap on how much a penal charge can be?
RBI's circular does not prescribe a fixed numerical cap applicable to all loans, but requires the charge to be reasonable and proportionate to the specific default, and prohibits compounding: interest cannot be charged on the penal charge amount itself.
Where can a borrower complain if a lender isn't following the penal charges framework?
A borrower can first use the lender's internal grievance redressal channel, and if the grievance is not satisfactorily resolved, escalate the complaint to the RBI Integrated Ombudsman Scheme.
References & Further Reading
This article references the following statutory provisions and regulatory materials. Readers should always verify current rules, circulars and timelines against the applicable statute, regulation or RBI direction as amended, since these are revised from time to time.
- Reserve Bank of India, Circular on Fair Lending Practice: Penal Charges in Loan Accounts.
- Reserve Bank – Integrated Ombudsman Scheme, 2021.