RBI Proposes to Eliminate Foreclosure Charges on MSE, Individual Business Loans

The Reserve Bank of India (RBI) has introduced draft guidelines aimed at regulating foreclosure charges and pre-payment penalties on loans. This move is part of the RBI’s efforts to promote fair lending practices and transparency, ensuring that borrowers especially individuals and Micro & Small Enterprises (MSEs) are not subjected to excessive fees when repaying their loans early.

RBI’s review revealed that some financial institutions impose high foreclosure charges and restrictive terms, making it difficult for borrowers to refinance with lenders offering better interest rates and services. These practices often lead to unnecessary financial strain, limiting access to more affordable credit options.

As part of its Statement on Developmental and Regulatory Policies issued on October 9, 2024, the RBI had committed to addressing these concerns. Now, through a Draft Circular (Reference No. RBI/2024-25/DoR.MCS.REC./01.01.001/2024-25) dated February 21, 2025, the central bank has proposed a new regulatory framework that will apply to Scheduled Commercial Banks, Non-Banking Financial Companies (NBFCs), and Co-operative Banks. This guideline aims to adopt a responsible lending approach among banks and financial institutions.

Key aspects of RBI’s draft circular are as follows:

1. No foreclosure or pre-payment penalties on floating rate loans for non-business purposes
2. For business loans availed by individuals and MSE borrowers, banks and NBFCs (except Tier 1 & Tier 2 Urban Co-operative Banks and Base Layer NBFCs) cannot impose foreclosure or pre-payment penalties. However, this exemption is limited to MSE loans with a total sanctioned limit of Rs. 7.50 crore or less per borrower.
3. Borrowers will not face penalties for repaying their loans early, regardless of the source of funds.
4. For dual-rate loans (a mix of fixed and floating interest rates), foreclosure charges will be calculated based on the interest rate type applicable at the time of pre-payment.
5. REs cannot impose a lock-in period for foreclosure or pre-payment of loans.
6. If a loan is foreclosed at the lender’s request, no penalty or extra charges can be levied.
7. Lenders must disclose all applicable charges upfront in the Key Fact Statement (KFS) at the time of loan sanctioning.
8. Retrospective charges (charges waived earlier or not disclosed initially) are strictly prohibited.

These new guidelines will replace existing regulations, including select portions of the NBFC – Housing Finance Company (Reserve Bank) Directions, 2021 (Feb 17, 2021) and the RBI (NBFC – Scale Based Regulation), Directions, 2023.

RBI has invited public feedback on the draft guidelines until March 21, 2025, via email.

Through these changes, RBI aims to foster fair lending practices and empower borrowers to make more informed choices without incurring unnecessary costs. By removing foreclosure charges and pre-payment penalties on loans, these regulations will introduce greater flexibility into the borrowing process, benefiting both individuals and small businesses. This move aligns with RBI’s broader goal of creating a more transparent and equitable financial ecosystem. Ultimately, these changes will lead to improved access to affordable credit, supporting the growth of both consumers and businesses across the country.