RBI bars foreclosure charges on floating rate loans to micro, small businesses

India Today

11 hours ago

The Reserve Bank of India has barred banks and non-banking financial companies (NBFCs) from charging prepayment penalties on floating rate loans to micro and small enterprises (MSEs), effective for all loans sanctioned or renewed on or after January 1, 2026.The directive, issued under the Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025, follows a supervisory review that found divergent practices among lenders. The review revealed that several institutions were levying prepayment charges inconsistently and, in some cases, including restrictive clauses in loan agreements to discourage borrowers from switching to other lenders offering better terms.Highlighting the importance of "easy and affordable financing" for MSEs, the central bank noted that such clauses often led to customer grievances and disputes, particularly when borrowers sought to refinance their loans at lower interest rates.According to the new rules, no prepayment charges will be allowed on floating rate loans to MSEs or to individuals borrowing for business purposes. This applies regardless of whether the loan is prepaid in part or full, and irrespective of the source of funds used to make the prepayment. The exemption will apply from the first day of the loan, with no lock-in period.An exception has been made for certain categories of lenders, including small finance banks, regional rural banks, state and central co-operative banks, and NBFCs in the middle regulatory layer, which are already barred from levying prepayment penalties on loans up to Rs 50 lakh. This framework will continue unchanged for these entities.In the case of cash credit and overdraft facilities, the RBI has clarified that no prepayment charges will apply if the borrower informs the lender of their intention not to renew the facility within the agreed period and ensures that it is closed by the due date.To strengthen transparency, the central bank has directed lenders to clearly disclose all applicable prepayment terms in the sanction letter, loan agreement and the Key Facts Statement (KFS), wherever applicable. Retrospective charges will not be allowed, and lenders cannot reintroduce any fees that were previously waived.Retail borrowers were already exempt from prepayment penalties under earlier rules. With this move, the RBI is extending similar protections to small businesses, which often face tighter credit conditions and limited ability to negotiate loan terms.The decision follows public consultations on a draft circular issued in February and is part of the RBI's broader effort to standardise customer-facing terms and reduce friction in the credit market.- Ends
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