The Reserve Bank of India, on 18 August 2023, issued a circular (RBI/2023-24/55) on the Reset of Floating Interest Rate on Equated Monthly Instalment (EMI) based Personal Loans, addressing widespread consumer grievances arising from the elongation of loan tenors and increased EMIs during the rising interest rate cycle. The circular imposes enhanced disclosure obligations on regulated entities and mandates that borrowers be given meaningful choices when interest rates are reset.
Background
During the period from May 2022 to February 2023, the RBI raised the repo rate by 250 basis points from 4 per cent to 6.5 per cent. This rate increase cascaded through the banking system, raising the external benchmark lending rates and marginal cost of funds-based lending rates. Borrowers with floating rate EMI loans — particularly home loans and personal loans — experienced significant impacts: some saw their monthly EMIs increase substantially, while others saw their loan tenors extend by years without any increase in the monthly payment amount.
The lack of timely and transparent communication about these changes created consumer hardship. Many borrowers discovered the impact of rate resets only when reviewing loan statements months later, without having been given an opportunity to adjust their repayment plans. Consumer forums and banking ombudsmen reported a surge in complaints related to the absence of proactive disclosure by lending institutions.
Key Provisions
The circular mandates the following:
Communication at sanction: At the time of loan sanction, regulated entities must clearly communicate to borrowers the impact that any future interest rate change will have on their EMI amount, loan tenor, or both. The communication must include illustrative examples showing the effect of rate changes.
Proactive disclosure at reset: Whenever a floating interest rate is reset, the lending institution must promptly communicate to the borrower: the revised interest rate, the revised EMI amount (if applicable), the revised tenor (if applicable), and the options available to the borrower.
Borrower options: At the time of every interest rate reset, borrowers must be offered the option to (a) increase the EMI amount to maintain the original tenor, (b) extend the tenor while maintaining the current EMI, or (c) switch from a floating rate to a fixed rate for the remaining tenor, subject to available options and applicable terms.
Quarterly statements: Regulated entities must provide quarterly statements to borrowers disclosing the principal recovered to date, interest recovered to date, current EMI amount, number of remaining EMIs, and the annualised rate of interest.
Negative amortisation prevention: If an increase in EMI is necessary to prevent the loan from entering negative amortisation — where the EMI is insufficient to cover even the interest component — the lender must immediately notify the borrower and implement the necessary adjustment.
Applicability: The circular covers all personal loans repaid through equated periodic instalments at floating rates. Both existing and new loans are covered, with regulated entities required to inform existing borrowers of available options by 31 December 2023.
Implications for Practitioners
Banking and consumer finance practitioners should advise lending institutions to implement comprehensive disclosure systems. The quarterly statement obligation requires integration into core banking systems with automated generation and delivery mechanisms.
For borrower-side practitioners, the circular provides regulatory backing for demanding clear information about rate reset impacts. Complaints about insufficient disclosure now have a specific regulatory standard to reference before the Banking Ombudsman or consumer forums.
Housing finance companies should note the fixed-rate switch option requirement, which compels them to develop fixed-rate products or conversion mechanisms. This may require pricing model adjustments and product development investments.