In a game-changing development, India’s Central Bank, the Reserve Bank of India (RBI), has taken a bold step directing all the banks and Non-Banking Financial Companies (NBFCs) across the country not to levy foreclosure charges or any pre-payment penalties on loans (with floating interest rates) with effect from January 1, 2026. RBI believes that the move enhances transparency and borrower flexibility in repayment of loans.
As announced in its Statement on Developmental and Regulatory Policies dated October 9, 2024, a draft circular was issued on February 21, 2025, for public feedback and consultation. On February 21, 2025, the RBI invited comments on the consultation paper seeking waiver of foreclosure charges and prepayment penalties, on loans availed by the Micro and Small Enterprises (MSEs).
The RBI has taken this move based on a review of several supervisory findings and public feedback received on its draft circular. Further, the Reserve Bank has issued the Directions in exercise of its powers conferred by Sections 21, 35A and 56 of the Banking Regulation Act, 1949, Sections 45JA, 45L and 45M of the Reserve Bank of India Act, 1934 and Section 30A of the National Housing Bank Act, 1987.
The Directions – officially known as Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025 – are applicable to all loans and advances sanctioned or renewed on or after January 1, 2026, and to all commercial banks (excluding payments banks), NBFCs, co-operative banks and other All India Financial Institutions.
As per the RBI Directions, “The exemptions from foreclosure charges or prepayment penalties shall be applicable irrespective of the source of funds used for loan pre-payment, either in part or in full, and without any minimum lock-in period.”
Loans to individuals
RBI said that for all loans sanctioned for non-business purposes to individuals, banks must not levy foreclosure/pre-payment charges, and it is immaterial whether the loan has been availed with or without co-obligant(s).
Business loans:
For all loans sanctioned to both individuals and MSEs, with or without co-obligant(s), for business purposes, RBI in its notification says:
“A commercial bank (excluding Small Finance bank, Regional Rural bank and Local Area bank), a Tier 4 Primary (Urban) Co-operative bank, an NBFC-UL, and an All India Financial Institution shall not levy any pre-payment charges.
(b) A Small Finance bank, a Regional Rural bank, a Tier 3 Primary (Urban) Co-operative bank, State Cooperative bank, Central Cooperative bank and an NBFC-ML shall not levy any pre-payment charges on loans with sanctioned amount/ limit up to ₹50 lakh.”
Disclosed in loan agreement
In cases wherein foreclosure charges or pre-payment penalties are applicable, say for instance, fixed-rate loans or in exemption cases as per new norms, the charges must be clearly disclosed in the sanction letter and in the loan agreement.
Further, in cases of loans for which Key Facts Statement (KFS) must be provided, these charges must be necessarily disclosed in the KFS. It must be noted that no pre-payment charges, which have not been mentioned in the document, shall be charged by the Registered Entities [REs(banks)]. Not just this, a registered entity cannot levy any fees, with retrospective effect, that were already waived off by it.
In its latest Directions, the Reserve Bank has mentioned that the availability of affordable loans to MSEs is of paramount importance. The Central Bank has stated that its supervisory reviews have indicated several divergent practices, among REs, regarding the levying of pre-payment charges for loans granted to MSEs that have led to customer grievances and disputes.
The RBI has also mentioned that certain REs were found to have included restrictive clauses in loan contracts/agreements thereby deterring borrowers from switching to another lender, either for better services or for lower rates of interest.
The RBI Directions say: “In case of cash credit/overdraft facilities, no pre-payment charges shall be applicable if the borrower intimates the RE of his/her its intention not to renew the facility before the period as stipulated in the loan agreement, provided that the facility gets closed on the due date. An RE shall not levy any charges where pre-payment is effected at the instance of the RE.”
What it means to common man?
The waiver of foreclosure charges or pre-payment penalties might attract more new borrowers into the formal system of credit. Chances are there that the move would, for sure, be a motivation and an incentive for the borrowers to repay their loans without default or keep extending their payment tenure. Further, the risk of hidden charges is considerably reduced, insofar as foreclosure charges. Till now, switching/porting the loans from one bank to another, has always been a nightmare, owing to the pre-payment penalties. Now that the foreclosure charges have been waived off, loan borrowers could easily port to other bank or NBFC, if at all he is not happy with the service offered in his existing bank.
Cheers! Catch you soon with another interesting and informative episode. Until then…