The Reserve Bank of India (RBI) has proposed a major reform in its latest draft circular, instructing banks and financial institutions to eliminate foreclosure charges and pre-payment penalties on all floating-rate loans. This move is aimed at providing greater financial flexibility to borrowers and ensuring a more competitive lending environment.
Under the new guidelines, if a borrower decides to repay a floating-rate loan early or foreclose it entirely, banks will no longer be permitted to impose additional fees or penalties. This measure is intended to empower borrowers, allowing them to switch lenders or close loans without financial deterrents.
The RBI’s draft circular, released on February 21, 2025, outlines that regulated entities (REs) cannot charge foreclosure fees on floating-rate term loans sanctioned to individual borrowers for non-business purposes, whether they are single borrowers or have co-obligants. The central bank has invited feedback from the public and relevant stakeholders on these proposed changes, with a deadline for responses set for March 21, 2025.
A key reason behind this proposal is the necessity for easy and affordable financing for Micro and Small Enterprises (MSEs), which play a crucial role in India’s economy. The RBI highlighted that banks must allow the prepayment or foreclosure of all floating-rate loans without additional costs, ensuring that small businesses have the financial agility to take advantage of better loan options.
The circular further specifies that all regulated entities, except Tier 1 and Tier 2 Primary (Urban) cooperative banks and Base Layer Non-Banking Financial Companies (NBFCs), must refrain from imposing foreclosure charges or penalties on floating-rate loans issued to individuals and MSE borrowers for business purposes. However, in the case of MSE borrowers, this exemption will only apply to loans with an aggregate sanctioned limit of up to ₹7.50 crore per borrower.
The RBI has also raised concerns over restrictive practices among financial institutions regarding foreclosure fees on MSE loans. It noted that some banks and NBFCs have been embedding clauses in loan agreements that discourage borrowers from switching to other lenders offering lower interest rates or better service terms. By implementing this new rule, the RBI aims to enhance competition in the lending market, ensuring that borrowers can access the best financial options without facing penalties.
Once finalized, this policy could have a significant impact on India’s banking landscape, particularly for small business owners and individual borrowers looking for more affordable financing options. The RBI’s push to eliminate anti-competitive loan clauses is expected to improve transparency in lending practices while encouraging financial institutions to offer more borrower-friendly terms.
The final decision on these regulations will be made after March 21, 2025, once all feedback has been reviewed, but if implemented, this rule could lead to lower borrowing costs and increased financial freedom for millions of borrowers across India.
