RBI Circular Concerning Prepayment Penalty

The Reserve Bank of India (RBI) has proposed a ban on prepayment penalties on retail and small business loans. The visions behind this proposal are expected to hamper lenders’ fee income and profitability.

Impact of the Provisions

• The impact is more likely to be harder on non banking financial companies (NBFCs) compared to banks.
• Competition is expected to increase, thereby switching borrowers between lenders.

Provisions of Draft Circular

• No penalties for prepayment or foreclosure on floating rate loans for individuals (non business purposes).
• No foreclosure charges on floating rate loans to MSMEs of up to ₹7.5 crore.
• Already exempted from prepayment are home loans, HFC or bank mortgage portfolios will not be impacted.

Expected Impact on NBFCs & Banks

• Foreclosure penalties on floating rate loans are not charged by major banks, thus NBFCs are more affected.
• The competing nature will affect NBFCs’ key loan segments, loan against property (LAP), SME loans, and business loans, causing reduced profitability.
• To counter losses, these lenders will likely:
  • Shift attention toward higher yielding customers and loans.
  • Increase interest rates or processing fees.
  • Achieve operational efficiency to maintain their profit margins.

Sector-Wise Exposure of Major Lenders (SME Loans, LAP, Business Loans in %)

It is expected that NBFCs and banks will submit feedback to the draft by March 21. Adjustments to lending strategies may follow to avert loss of revenue. Increase in lending rates or processing fees may be affected.