Decoding RBI's FAQs On Reset Of Floating Interest Rate On EMI Based Personal Loans

I. Introduction

As part of its broader, long-standing effort to ensure fairness and borrower protection in India's credit ecosystem, on 10 January 2025, the Reserve Bank of India (RBI) released responses to frequently asked questions (FAQs) pertaining to the RBI circular - Reset of Floating Interest Rate on Equated Monthly Instalments (EMI) based Personal Loans dated 18 August 2023 (RBI Circular).

The RBI Circular was introduced to ensure that borrowers were adequately informed in cases where interest rates on equated instalments based personal loans are reset or otherwise increased. These floating interest rates, which fluctuate based on changes in an underlying reference benchmark, have been a key feature of the personal loan and housing finance segments. While floating rates offer borrowers the potential benefit of reduced rates during periods of monetary easing, they also expose them to increased repayment obligations during periods of rate hikes. To this effect, the RBI Circular places an obligation on Regulated Entities (REs), including, inter alia, scheduled commercial banks, non-banking financial companies, and housing finance companies, to notify borrowers of any increase in the EMI amount, tenor, or both as a result of a reset of the floating interest rate, thereby promoting borrower-friendly practices.

II. Key highlights of the FAQs

The RBI Circular required REs, at the time of granting EMI based floating rate personal loans to take into account the repayment capacity of borrowers to ensure that adequate margin is available for the elongation of tenor and / or increase in EMI of such loan, in case the external benchmark rate (which such personal loan is pegged to) increases during the tenor of the loan. In this light, the RBI Circular sets out certain requirements to be complied with by the REs while modifying the loan tenor and / or revising the due EMI amounts. The FAQs have provided the below clarifications in this regard.

1. The RBI Circular provides that the REs shall communicate to the borrowers the impact of interest rate reset on EMI, in floating rate personal loans, both at the time of sanction and during the tenure of the loan. The FAQs further elaborate that such communication would include the following:
   
   1. At the time of sanction. Annualised rate of interest / annual percentage rate, as applicable, to be disclosed in the key fact statement and the loan agreement; and the possible impact of change in benchmark interest rate on the loan shall be communicated.
   2. During the tenure of the loan. Any increase in the EMI / tenor on account of the external benchmark rate shall be communicated, and quarterly statements shall be provided disclosing at the minimum, the principal and interest recovered till date, EMI amount, number of EMIs left, and annualized rate of interest for the tenor of the loan.
2. The RBI Circular provides that REs shall intimate the different options available to address the increase in EMI in a rising interest rate scenario. The FAQs clarify that when there is a reset in the interest rate for an entire class of borrowers in a particular loan category, the different options provided to borrowers would include:
   
   1. enhancement in EMI / elongation of number of EMIs, keeping the EMI unchanged / a combination of both options;
   2. switch to fixed interest rate for the remaining portion of the loan; and
   3. prepayment, either in part or in full, at any point during the residual tenor of the loan.
3. The RBI Circular provides that REs shall provide the option to the borrowers to switch over to a fixed rate as per their Board approved policy, at the time of reset of interest rates. The FAQs, in this regard, elucidate that accordingly, REs must mandatorily offer a fixed interest rate product in all EMI based personal loan categories, so that the borrowers have the option to switch. Further, REs shall permit borrowers to switch back to a floating rate loan, since the intent is to allow flexibility to the customer. The REs shall specify the number of times a borrower will be allowed to switch during the tenor of the loan, under their Board approved policy.
4. The FAQs clarify that the RBI Circular covers all equated instalment based personal loans, irrespective of whether they are linked to an external benchmark or an internal benchmark.
5. The FAQs elaborate the following in terms of applicable charges in relation to the loan products:
   
   1. REs can levy applicable charges for the following: (A) switching of loans from floating to fixed rate or vice versa; and / or (B) any other service charges / administrative costs incidental to the exercise of the switchover options.
   2. The charges shall be transparently disclosed in the sanction letter and at the time of revision of such charges / costs by the RE.
   3. The charges shall be approved the Board of the RE and displayed on their website.
6. The RBI Circular provides that a maximum tenure of 20 years is applicable to urban co-operative banks in case of housing loans. The FAQs clarify that extending the housing loan of the borrower for more than 20 years, during the switch over from floating rate to fixed rate and vice versa or if the borrower opts for elongation of tenor for a floating rate loan at the time of reset of interest rates, can be allowed subject to adherence to the regulations under the RBI's Master Circular on Housing Finance for UCBs dated 11 April 2023.

III. Comment

The RBI Circular is an attempt to strike a balance between promoting market-linked interest rates and protecting borrowers from undue hardships. It ensures that borrowers are provided with the information imperative to making decisions on their personal debt obligations arising from floating rate EMI based personal loans. Considering that one of the primary benefits of a floating interest rate personal loan is its flexibility for borrowers, this aspect must be protected and facilitated, which the RBI Circular achieves. The FAQs, by further clarifying the obligations laid out in the RBI Circular and their subsequent implementation, ensure greater transparency, flexibility, and borrower protection, reinforcing the RBI's commitment to fair lending practices.

The content of this document does not necessarily reflect the views / position of Khaitan & Co but remain solely those of the author(s). For any further queries or follow up, please contact Khaitan & Co at editors@khaitanco.com.