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| Photo Credit: The Hindu
The story so far: On February 21, the Reserve Bank of India (RBI) floated a consultation paper seeking to waive foreclosure charges, and prepayment penalties, on loans taken by micro and small enterprises (MSEs). At present, banks and non-banking financial institutions (NBFCs) cannot levy the same on any term loan at floating rates of an individual borrower. The proposals thus extend these provisions to MSEs for business purposes emphasising the “paramount importance” of “easy and affordable” financing for them. Comments to the proposed measures are solicited until March 21.
What all has RBI proposed?
RBI has proposed that banks and NBFCs must not levy foreclosure charges or prepayment penalties on loans taken at floating rates by MSEs for business purposes. At present, the provision only exists for loans taken by individuals for purposes other than business. The proposed regulation thus extends the purview of the guideline. This shall apply to all MSE borrowing up to ₹7.5 crore barring an exception for Tier 1 and Tier 2 Primary (Urban) Co-operative Banks and base layer NBFCs, that is, those with asset sizes of below ₹1,000 crore.
The apex banking regulator also underlines that banks and NBFCs cannot stipulate any minimum lock-in period for the proposed guidelines to become applicable. Furthermore, it underlines that regulated entities cannot levy any retrospective charges which were waived off earlier and/or not disclosed in advance to the borrowers. As for loans with dual rates (that is, fixed and floating rates), the guidelines – which specifically apply to those for floating rates, shall become applicable only if the loan adheres to a floating rate when prepayment or foreclosure is opted for.
The primary objective of the proposed measures is to provide for easy and affordable financing to MSMEs. RBI observed in their supervisory review about the existence of “divergent practices” in sanction of loans to MSMEs. These, it observed, led to customer grievances and disputes. Significantly, the regulator noted banks and NBFCs included restrictive clauses in loan agreements that restrained MSE borrowers from switching to an alternate lender.
Do moving loans for MSMEs ease with the proposed measures?
Vivek Iyer, Partner and Financial Services Risk Leader at consulting firm Grant Thornton Bharat told The Hindu that the waiver would bring more borrowers into the formal system (of credit). He added that regulatory clarity would be important to first time borrowers in this segment, as it “mitigates the risk of hidden charges and offers better ability for MSMEs to plan their cash flows and incentivises borrowers to repay.” Validating this, M. Karthikeyan, President at the Coimbatore District Small Industries Association (CODISSIA) said 3-5% of their affiliated units seek foreclosures. He explained that an small and medium enterprise (SME) opts for foreclosure to move to another bank because they face issues in availing additional loans from the same bank. “Some say that when a loan is sanctioned, the foreclosure charges are considered and hence, this cannot be followed for existing loan accounts. Each bank has its own set of rules,” stated Mr. Karthikeyan.
Mithun Ramdass, President at the Southern Indian Engineering Manufacturers Association (SIEMA), said switching loans has been a “nightmare” because of the foreclosure charges and inordinate delays in processing papers. “The RBI should put in place a time limit for processing and terminating loans or moving it to another bank by MSME owners,” Mr. Ramdass suggested.
Does it free up more money for MSEs?
The proposed measures are meant to help small businesses to clear their debts without penalties. Banks also seek penalties as compensation for loss in interest payments on early exits. While an early exit from loan obligations helps ease the debt stress of MSMEs. NBFC IIFL Finance said in a blogpost (Dec 2024) that the waiver on foreclosure would be “extremely beneficial” to MSMEs and their working capital loans as it is commonplace to pay before the date.
J. James, president, Tamil Nadu Association of Cottage and Tiny Enterprises (TNACTE), says that about a quarter of micro or cottage units are unable to avail a loan because banks insist on collateral. “When most of the micro units operate in rented building, they are unable to pledge property documents. Banks should lend more to micro units without asking for collateral,” he stated.
What does this mean for banks and NBFCs?
According to Adhil Shetty, CEO, BankBazaar.com, what is good for the consumer would in turn be good for the industry. “Foreclosure charges had been waived off retail loans in the past, and this was welcomed by consumers. Now this benefit may be extended to SME loans,” he said.
But according to an IIFL Capital report, the proposed measures could reduce profitability of retail products such as loan against property (LAP), small and medium enterprises’ loans (SME) and business loans. IIFL Capital argues that this would be due to a potential increase in competition. It says that the small businesses segments constitute about 5% to 25% of assets under management for NBFCs and housing financial companies (HFC). It holds that NBFCs with lower cost of funds, that is, the cost incurred by the lender to borrow in the interbank market – and backed by a strong parent entity- could be partially offset by raising the share of more granular and higher yielding customers when loans (via balance transfer) are moved to them from smaller peers. Additionally, the financial services company expects that over the medium term, this would also increase competitiveness in the fixed rate non-housing loan (NHL) segment of affordable housing financial companies (AHFCs) though they have not been covered in the circular. This would be as large NBFCs seek to compete on rates.
Published – March 02, 2025 10:33 am IST
