On July 2, 2025, the Reserve Bank of India (Pre-payment Charges on Loans) Directions, 2025 ("Directions") were issued by the Reserve Bank of India ("RBI"). The Directions intend to regulate the pre-payment charges levied by Commercial Banks (excluding Payments Banks), Co-Operative Banks, All-India Financial Institutions and Non-Banking Financial Companies ("REs") in relation to loans sanctioned on or after January 1, 2026.
Prior to the Directions coming into place, the regulatory landscape for prepayment charges was fragmented, with different rules applying to different categories of REs and loan types. As a result, the REs invariably followed divergent practices regarding the levy of prepayment charges/ penalties.
RBI, pursuant to the Directions, has sought to regulate these charges imposed by REs particularly for Micro and Small Enterprises ("MSEs") and individuals.
Key provisions of the Directions
Restrictions for loans advanced at floating interest rates
Following restrictions have been imposed on loans granted at floating rates of interest by REs:
1. REs are restricted from levying pre-payment charges in respect of all loans granted for purposes other than business, to individuals, with or without co-obligant(s) [Direction 5(i)];
2. All Commercial Banks (excluding Small Finance Bank, Regional Rural Bank and Local Area Bank), Tier 4 Primary (Urban) Co-operative banks, Non-Banking Financial Companies - Upper Layer and All India Financial Institutions are restricted from levying pre-payment charges in respect of all loans granted for business purposes, to individuals and MSEs, with or without co-obligant(s) [Direction 5(ii)(a)]; and
3. All Small Finance Banks, Regional Rural Banks, Tier 3 Primary (Urban) Co-Operative Banks, State Cooperative Banks, Central Cooperative Banks And Non-Banking Financial Companies - Middle Layer are restricted from levying pre-payment charges in respect of all loans with sanctioned amount of up to INR 50,00,000 (Indian Rupees fifty lac), granted for business purposes to individuals and MSEs, with or without co-obligant(s) [Direction 5(ii)(b)].
In respect of loans sanctioned at dual/ special rate i.e., a combination of fixed and floating rate, the applicability shall be contingent on whether or not the loan is at a floating rate of interest at the time of pre-payment [Direction 5(iv)].
Applicability, source of funds and lock-in period
The restrictions as enumerated in paragraph 1 above will be applicable in respect of early repayment of scheduled instalments i.e., part of the loan as well as full prepayment and foreclosure of the loan, without any requirement of a minimum lock-in period [Direction 5(iii)]. Further, the restrictions on pre-payment charges being levied are applicable irrespective of the source of funds utilised for prepayment [Direction 5(iii)].
Other restrictions on pre-payment charges
1. Pre-payment charges are permitted to be levied on term loans as long as they are based on the amounts being prepaid [Direction 6].
2. Pre-payment charges in respect of cash credit/ overdraft facilities can only be levied on an amount upto the limit sanctioned for such facility [Direction 6]. Further, if the borrower of a cash credit/ overdraft facility intimates the RE of their intention to not renew the facility within the relevant period stipulated under the facility agreement, the RE is restricted from levying any pre-payment charges [Direction 7].
3. Where any prepayment is effected at the instance of the RE, such RE is restricted from levying pre-payment charges [Direction 8].
REs to have an internal approved policy
All pre-payment charges, other than those specifically prohibited under the Directions, are permitted to be imposed only as per the approved policy of the REs [Direction 6].
No retrospective application
REs are restricted from retrospectively levying any fees or charges in respect of the loan, at the time of pre-payment, which have been waived off earlier [Direction 10].
Disclosure requirement
REs are required to explicitly disclose the pre-payment charges which shall be levied for each facility in the key fact statement (if applicable), sanction letter and loan agreement pertaining to the facility, and REs are restricted from levying any pre-payment charges which have not been disclosed [Direction 9].
Analysis
The Directions signify RBI's aim to allow greater flexibility, especially for MSE and individual borrowers, by eliminating pre-payment penalties and other contractual hurdles that have been deterring customers from switching over from costlier loans. This will pave way for more competitive rates of interest being offered by REs and better customer service rather than reliance on lock-in periods and pre-payment penalties on pre-payment through refinance or other sources. The individuals and MSEs availing loans at floating rate of interest for business purposes shall, however, need to carefully consider the type of lender from whom to avail funding given the tiered system of restrictions under the Directions, where certain REs such as Tier 1 and Tier 2 Primary Urban Co-operative Banks and NBFCs - Base Layer are exempted from the prohibition on pre-payment charges for loans advanced at a floating rate of interest.
The Directions will further result in increased transparency through the mandatory disclosure requirements and restrictions on retrospective application of pre-payment charges. The requirement for REs to put in place an approved policy for levy of pre-payment charges and to ensure that all loan documentation specifically provides for the applicable pre-payment charges, will also safeguard borrowers against arbitrary and undisclosed levies.
Please find a copy of the Directions, here.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
