Prepayment penalty ban to hurt NBFCs more than banks, say experts

Business Standard

19 hours ago

The fee income of banks and non-banking finance companies (NBFCs) will come under pressure following the Reserve Bank of India 's decision to bar prepayment penalties on fresh loans for micro and small enterprises, effective from 1 January 2026. However, the impact on NBFCs will be more significant compared to commercial banks, experts said.
NBFCs have around 5-25 per cent of their assets under management (AUM) in floating-rate micro, small, and medium enterprises (MSME) loans, which will be impacted, as the majority of them charge 2-5 per cent prepayment penalties. At the same time, fee income for banks is less than 1 per cent of their total income, so the impact of these changes will be minimal on banks, industry experts said.
'It will have a negative impact on the non-operating income component of the regulated entities, which are focused on MSMEs and have longer-tenured floating-rate loan products,' said Sachin Sachdeva, Vice President, Financial Sector Ratings, ICRA Limited. 'Nevertheless, with these directions, the central bank has tried to harmonise the practice across lenders, given the divergent practices among banks and NBFCs, and at the same time, it increases the affordability of financing for micro and small enterprises,' he added.
An exception was made for small finance banks, urban co-operatives, and regional rural banks, as these entities are barred from charging such penalties on loans up to Rs 50 lakh. The directions are applicable irrespective of the source of funds used for prepayment of loans, either in part or in full, and without any minimum lock-in period.
NBFCs such as PNB Housing Finance, Aditya Birla Capital, and Piramal Enterprises are expected to be impacted the most, as they account for the majority of floating-rate MSME loans and loans against property (including MSME loans). According to an IIFL Securities report, PNB Housing Finance accounts for 27 per cent of floating-rate MSME loans, followed by Aditya Birla Capital, which holds 26 per cent, and Piramal Enterprises, which accounts for 22 per cent.
The report also indicated that there would be a material increase in competitive intensity in loans against property and floating-rate MSME loans, reducing their profitability structurally as exit barriers are removed.
'Banks and large NBFCs with lower cost of funds will be able to partially offset this by increasing the share of more granular and higher-yielding customers within these segments,' the report said.
'Currently, we levy a 4 per cent fee/penalty on full early payment and 2 per cent for part pre-payment. With these changes, we will have to bear a loss of 2-4 per cent,' said an official with an NBFC.
Meanwhile, the impact on banks will be limited, as fee income is near 1 per cent of a bank's total income, bankers said.
'As a bank, pre-payment fees account for just 0.5-0.6 per cent of total income, so the impact will be minimal. Earlier, we could enter into a lock-in period for pre-payments; now we have to forego that,' said a senior banking official at a public sector bank.
From a customer's perspective, the circular on prepayment charges is a positive move by the regulator to ensure that customers are protected from prepayment charges upon loan closure, said Sanket Agrawal, Chief Strategy Officer, SBFC Finance. 'However, it is important to note that the circular applies to floating-rate loans sanctioned on or after 1 January 2026, which means that the loan book as of today does not get impacted. Also, a borrower does not typically close a higher-tenure loan in the first few years, and therefore the impact of the circular on prepayment fee income of finance companies will be at a lag. This circular helps borrowers access credit at a fair price in their long-tenure repayment cycle,' he said.