Penal Charges on Loans: What Banks Can and Cannot Charge

TL;DR

• Since April 2024, a loan penalty must be a flat penal charge, not penal interest added to your loan rate.
• A penal charge never compounds. No further interest can be charged on the charge itself.
• RBI sets no rupee cap. The charge must be reasonable, disclosed upfront, and no higher for an individual borrower than for a business borrower.
• A flat charge can still cost more than old penal interest on a small, short delay. Check the worked example before assuming the new rule saved you money.

Priya has a personal loan with an EMI of Rs 25,000. She misses two EMIs, so Rs 50,000 stands overdue. Her statement shows a penalty, and she assumes the new RBI rule made it cheaper. It did not, at least not at first. Under the old penal interest method, 90 days of penalty on Rs 50,000 at 2 percent a year would have been Rs 246.58. Under the new method, her lender levies a flat Rs 400 per missed EMI, so two missed EMIs cost Rs 800. The new rule helps her only if the delay runs long, because the flat Rs 800 never grows, while the old penalty would have kept growing every day. This guide explains that trade in full, so you can read your own statement with the right test.

One reading rule. This page is general information under Indian banking directions as of October 2026, not legal or tax advice. Where a rule comes from an RBI circular, this page says so and quotes the operative wording. Where a number is an illustrative example, this page says that too. Only your loan agreement, sanction letter, and Key Fact Statement bind your lender on the exact charge for your loan. For what a sanction letter must carry, see the sanction letter guide.

What is the difference between penal interest and penal charges?

Penal interest was an extra rate added to your loan rate. If your loan rate was 12 percent and the penal rate was 2 percent, the overdue amount carried 14 percent while it stayed unpaid. The penalty grew with time and with the amount overdue, and in many loan agreements it was capitalised, which means it was added to the outstanding and then earned interest itself. Penal charges work differently. A penal charge is a flat fee for a specific default, such as a missed EMI or a broken loan condition. It is shown as its own line, it is not added to your interest rate, and it does not earn further interest. That single change is the whole reform: the penalty stops behaving like interest.

The distinction also changes what you can check. Under penal interest, you needed the rate, the base amount, and the day count to verify the penalty, and the base kept moving as interest compounded. Under penal charges, you need three simpler facts: the event that triggered the charge, the flat amount for that event, and whether that amount matches the disclosure in your loan papers. If any of the three is missing from your statement, you have a concrete question to put to the lender in writing. The worked example later in this guide shows both methods side by side on the same missed EMIs, so the difference is visible in rupees, not just in words.

What did RBI change in August 2023, and when did it take effect?

On 18 August 2023, the Reserve Bank of India issued circular DoR.MCS.REC.28/01.01.001/2023-24, titled Fair Lending Practice: Penal Charges in Loan Accounts. The circular covers commercial banks, small finance banks, local area banks, regional rural banks, primary urban co-operative banks, NBFCs including housing finance companies, and all India financial institutions. Payments banks are excluded from the addressee list. The circular says supervisory reviews had found divergent practices in penal interest, leading to customer grievances and disputes, and that penal charges are meant to inculcate credit discipline, not to serve as a revenue enhancement tool over and above the contracted rate of interest.

The original start date was 1 January 2024. On 29 December 2023, RBI extended it by three months through circular DoR.MCS.REC.61/01.01.001/2023-24. Under the extension, fresh loans availed from 1 April 2024 onwards fall under the new regime, and existing loans switch on the next review or renewal date falling on or after 1 April 2024, but not later than 30 June 2024. That is why a statement from early 2024 can still show the old method for an older loan, while a statement from late 2024 should not. Check the date of your loan and the date of the charge before concluding that a lender broke the rule.

One confusion is worth clearing. Some secondary pages describe the August 2023 circular as withdrawn. The circular itself says its instructions shall be updated in the relevant Master Directions and Master Circulars of each regulated entity, with an annex of amendments. In other words, the text was folded into the standing directions. Folding a circular into a Master Direction is consolidation, not repeal. The rules below remain the operative rules, and this guide cites the circular numbers so you can quote them to your lender.

What are the rules banks must follow now?

The August 2023 circular sets eight instructions. The wording below follows the circular closely, because the modal words matter: where RBI says shall, the rule is mandatory, and where RBI says reasonable, the standard is deliberately open. Read each rule as a test you can apply to your own statement.

• Penalty for non-compliance of material terms and conditions shall be treated as penal charges, and shall not be levied as penal interest added to the rate of interest on the advances.
• There shall be no capitalisation of penal charges. No further interest shall be computed on such charges. Normal compounding of interest in the loan account is unaffected, so contracted interest on unpaid amounts still runs.
• Lenders shall not introduce any additional component to the rate of interest, and shall comply in both letter and spirit.
• Each lender shall formulate a Board approved policy on penal charges or similar charges on loans, by whatever name called.
• The quantum of penal charges shall be reasonable and commensurate with the non-compliance, without being discriminatory within a particular loan or product category.
• Penal charges for individual borrowers, for purposes other than business, shall not be higher than the charges for non-individual borrowers for similar non-compliance.
• The quantum and reason for penal charges shall be clearly disclosed in the loan agreement and in the most important terms and conditions or Key Fact Statement, as applicable, and displayed on the lender website under Interest rates and Service Charges.
• Whenever reminders for non-compliance are sent, the applicable penal charges shall be communicated, and every instance of levy and its reason shall also be communicated.

The RBI FAQ page adds four clarifications that close common loopholes. First, penal charges are levied only on the amount under default, not on the full loan outstanding. Second, additional penal charges cannot be levied on the earlier outstanding amount of penal charges, which means a lender cannot charge a penalty on an unpaid penalty. Third, a website schedule plus a mere reference to it in the sanction letter or agreement is not enough: the quantum and reason must be disclosed upfront in the agreement and in the most important terms and conditions or Key Fact Statement. Fourth, in NPA accounts, penal charges are reversed to the extent they remain uncollected for income recognition purposes, but they remain part of your liability unless waived under the Board approved policy. Do not mistake an income-recognition reversal for a waiver.

Is there a cap on how much a bank can charge?

No. RBI prescribes no upper limit or cap for penal charges, and the RBI FAQ says so directly. That absence is deliberate, and it is the part most borrower guides get wrong by inventing a percentage. What RBI gives instead is a standard and two comparisons. The standard is reasonable and commensurate with the non-compliance. The comparisons are within a loan or product category, where the charge must not be discriminatory, and between borrower types, where an individual borrower for a non-business purpose must not pay more than a non-individual borrower for a similar default. A charge that fails any of those three tests is challengeable even though no cap exists.

Because there is no cap, your loan papers matter more than any article. The charge for your loan is the figure in your agreement and Key Fact Statement, read against the lender Board approved policy and the website schedule. If the three do not match, ask for the match in writing. The same logic applies to tax: RBI defers GST questions to the Central Board of Indirect Taxes and Customs, and the Board clarified on 28 January 2025 that no GST is payable on penal charges levied by regulated entities in compliance with the August 2023 directions, because such charges are liquidated damages for breach rather than consideration for a service. Older statements may still show GST, so check the statement date before treating a GST line as wrong.

One more limit deserves attention. The circular says nothing about waiving a penal charge on request, and no waiver right should be read into it. Waiver, if offered, comes from the lender Board approved policy or from a settlement discussion, not from the circular. If you are negotiating a settlement, read the one time settlement guide before treating any waiver promise as final, and get any waiver in writing before you pay the balance.

What does the change mean in rupees?

Take Priya again. Her personal loan EMI is Rs 25,000. She misses two EMIs, so Rs 50,000 is overdue. Her contracted rate is 12 percent a year. Under the old method, the penal rate is 2 percent a year on the overdue amount. Under the new method, her lender charges a flat Rs 400 per missed EMI. Both figures below are computed on the same 90 days unpaid, so the comparison is clean. The flat charge and the penal rate in this example are illustrative lender figures, not RBI figures, because RBI prescribes no amount. Change the inputs in the free workbook and the comparison updates for your own loan.

Three lessons follow. First, at 90 days the new method costs Priya Rs 553.42 more than the old method, because a flat Rs 800 beats 90 days of 2 percent interest on Rs 50,000. Second, the normal contracted interest of Rs 1,479.45 is payable under both methods. It is interest on the unpaid EMI, not a penalty, and the RBI FAQ confirms that lenders may charge it at the contracted rate until the amount is paid. Never add that line to the penalty when you compare methods, or you will overstate the penalty in both columns. Third, the old method catches up only on day 292, when 292 days of penal interest on Rs 50,000 at 2 percent reaches Rs 800. After that day, the old method costs more every day, and capitalisation would widen the gap further. The new rule protects long delays, not short ones.

A larger business case shows the other side. On Rs 3,00,000 overdue for 180 days, at a contracted rate of 11 percent and an old penal rate of 2 percent, the old penalty is Rs 2,958.90, while four flat charges of Rs 400 total Rs 1,600, a saving of Rs 1,358.90 under the new method. The break-even day there is about day 97. The lesson is general: a flat charge favours large, long defaults and penalises small, short ones. That is why the workbook carries both cases. Enter your own overdue amount, rate, days, and flat charge, and read your own break-even day before you decide whether the new rule helped you or hurt you.

Which loans sit outside these rules?

Four categories are expressly left out of the August 2023 circular: credit cards, external commercial borrowings, trade credits, and structured obligations, because those sit under product-specific directions. The RBI FAQ adds two more exclusions: rupee and foreign currency export credit, and other foreign currency loans. If your facility is in one of these categories, do not quote this circular to the lender. Quote the product direction that actually governs it. For a working capital facility, the position is the opposite: the FAQ confirms the circular applies to all credit facilities except those specifically exempted, so cash credit and overdraft facilities are inside the rules, and the penalty on them must also take the penal charge form.

Two boundary cases are worth knowing. If a bank guarantee is invoked or a letter of credit devolves, the funded facility created can carry interest reflecting its credit risk premium under the bank underwriting policy, but any penalty on non-repayment of that facility may only be a penal charge, not penal interest. If your loan is part of a securitisation or co-lending portfolio, the circular still applies. Neither boundary case changes the core test: if the amount is a penalty for non-compliance, it must be a flat, disclosed, non-compounding charge. For how a guarantee invocation works from the borrower side, see the bank guarantee guide, and for letter of credit charges, see the letter of credit guide.

How do you check a penal charge on your own statement?

Work through five checks in order, and keep a dated copy of each document you rely on. First, find the penalty line and the event behind it. A line that only says charges, with no event and no reason, already fails the communication rule, because every levy and its reason must be communicated. Second, match the amount to your loan agreement and Key Fact Statement. If the amount is not there, or if it differs, note the mismatch in writing. Third, check the base: the charge must sit on the amount under default, not on the full outstanding, and no fresh charge may sit on an earlier unpaid penal charge. Fourth, check the form: if the line reads as an added rate, or if the charge itself appears to earn interest in the next statement, that is the old method surviving past its date. Fifth, check the date: fresh loans from 1 April 2024 and existing loans switched by 30 June 2024 at the latest should all be on the new method.

If a check fails, write to the lender, quote the circular number DoR.MCS.REC.28/01.01.001/2023-24, state the line, the amount, and the check that failed, and ask for a written correction or explanation. Keep the reply. Escalation through the lender grievance route comes first in practice, because the lender holds the statement and the policy, and a written trail is what any later forum will ask for. Do not pay a disputed charge silently and then argue about it months later: a paid line is harder to reopen than an open query, and the statement date matters for every later step. For the wider appraisal file that surrounds a loan, including how officers read your statements, see the credit appraisal process guide.

Does a penal charge hurt your credit score?

A penal charge, by itself, is a fee, and this guide does not claim that a fee line alone moves a credit score. What moves a record is the missed payment behind the charge. Lenders may report missed payments to credit bureaus, and a missed EMI can then sit on the borrower record even after the penal charge is paid. That is why the two lines must be handled separately: clear the missed EMI, and separately confirm that the penal charge was levied correctly. Paying only the penal charge leaves the missed payment open, and clearing only the EMI leaves an unpaid penal charge that can itself draw reminders. For how missed payments and obligations are read together, see the CIBIL versus bank statement guide and the FOIR guide, which explains how fixed obligations shape the next sanction.

The same separation applies to recovery. A penal charge does not, by itself, turn a loan into a recovery case, and this guide does not teach recovery procedure. If a loan stays unpaid long enough to reach enforcement or settlement, the penal charge becomes one line among many in a much larger file. For those later stages, read the SARFAESI guide and the one time settlement guide linked above, rather than stretching this circular beyond its scope. The circular governs the form, disclosure, and compounding of the penalty. It does not decide whether a loan is recoverable, and it does not waive anything.

Sources

Primary sources: Reserve Bank of India circular DoR.MCS.REC.28/01.01.001/2023-24, RBI/2023-24/53, 18 August 2023, Fair Lending Practice: Penal Charges in Loan Accounts, full text read on rbi.org.in; RBI circular DoR.MCS.REC.61/01.01.001/2023-24, RBI/2023-24/102, 29 December 2023, extension of timeline; RBI FAQ page, Fair Lending Practice: Penal Charges in Loan Accounts, rbi.org.in FAQ section. Secondary context, labelled as such in the text: Central Board of Indirect Taxes and Customs clarification of 28 January 2025 on GST for penal charges, as reported by the Economic Times; competitor borrower guides and news reports of the 2023 circular used only for gap analysis. No lender-specific tariff is stated in this guide, and no rupee figure is attributed to RBI.

Official sources: RBI circular, 18 August 2023, RBI extension circular, 29 December 2023, and RBI FAQ on penal charges.

Frequently Asked Questions

Last updated: October 2026. Framework cited: RBI circular DoR.MCS.REC.28/01.01.001/2023-24 of 18 August 2023, extension circular DoR.MCS.REC.61/01.01.001/2023-24 of 29 December 2023, and the RBI FAQ page on penal charges.