RBI disapproves of pre-payment penalty

The Reserve Bank of India (RBI) has expressed its disapproval over the practice to charge consumers a ‘penalty’ if they pay their loans in advance of the scheduled period. Banks, particularly private sector players, charge anything between 2% and 5% of the principal sum and/or a lump sum for the same.

Many banks prefer to punish the customer for being conscientious and paying the sum due before time.

Representations on such unfair trade practices have been flooding the RBI. The banks have been evading the questions by stating that once they book a loan and plan for the incoming interest over the years, the consumer is upsetting their plans by pre-paying the loan in advance!

The penal interest, it is explained, is to cover the bank’s notional losses in finding a new customer who will take a loan and to dissuade the original customer from increasing the bank’s load by returning the money and the extra work emanating therefrom.

Surprisingly, the RBI has expressed only concern and dismay at the attitude. Part of the reason for this reluctance is the terms and conditions laid down by the banks in the contract papers. The penalty clause is usually incorporated prominently in the contract and the authorities do not wish to disturb the established precedent of not interfering in a private contract.

There is however, in the Indian Contracts Act, a provision for an authority to strike down a clause in a contract if it is either ‘unconscionable or against public policy’. It is high time the RBI used this rule and learns to bite instead of barking at commercial banks.