On 29th April 2024, RBI released a notification on the Fair Practice Code for Lenders – Charging of Interest.

In this article, I will try to address the below-highlighted unfair practices

“Charging of interest from the date of sanction of loan or date of execution of loan agreement and not from the date of actual disbursement of the funds to the customer.

Similarly, in the case of loans being disbursed by cheque, instances were observed where interest was charged from the date of the cheque whereas the cheque was handed over to the customer several days later”

It is not necessarily an issue with lenders intent but there are practical challenges involved too

  • In the sanction letter and KFS, we need to show the repayment schedule.
  • In a loan agreement, displaying the repayment schedule is required.
  • Lenders generate these repayment schedules by assuming that funds will be disbursed on the date of agreement/sanction.
  • The customer signs the repayment schedule in the loan agreement even before receiving the funds
  • If fund disbursement gets delayed for whatever reasons, it would also directly impact the repayment schedule.
  • Should the repayment schedule be regenerated on the actual payment date and should the customer re-sign the new repayment schedule?

Disbursement and payment are two different events

  • Event#1: Disbursement in Loan Management System
    • It is an activity performed by the lender’s ops team and the loan number is generated in the LMS
    • This activity creates a liability – “Payable” in the books
  • Event#2: Actual payment to the beneficiary
    • On disbursement, payable Liability is created in the LMS
    • The same needs to be paid to the customer either through
      • Automation – Bank integrations via API / SFTP
      • Manual bulk upload process – A bank ops employee manually downloads the “Pending Payment” report and makes the payment via bulk upload
      • Cheque printing – Bank ops gets the cheques printed and posted to branches

These can technically be on a different date for operational reasons. RBI may not have an objection to this.

Their objection is – interest should be charged from the actual payment date (Fund disbursement date / Cheque handover date) and not from the other dates – Sanction date / Agreement date / Disbursement date.

Why does the actual fund disbursement take time after the loan agreement?

  • Due to a lack of automation
    • A significant number of lenders do not have automation in loan amount payouts
    • The operation team downloads the pending payment report at a certain frequency – weekly/daily/monthly and then uploads it for bulk payments.
    • This process has its inherent delays of a few days
  • Due Diligence / Non-Discrepancy Checks
    • In non-digital loans, all the documents are manually verified by the ops team before the disbursement including the loan agreements and all other documents in the loan file.
    • This is a time-consuming activity and can take anywhere from 1 day to a few weeks
  • Conditional handover of cheque (OTC)
    • OTC/PDD dependencies are a popular term in lending
    • OTCs (Over The Counter) – are dependencies that the borrower needs to fulfil to collect the cheque from the lender.
    • The lender prints the cheque beforehand and it lies in their branch. In these cases, lenders put the date of cheque printing as the date of loan disbursement
  • Mortgaging process
    • In the case of agri-loans and some cases vehicle loans, lenders need to first complete the mortgage process and then disburse the loans

How to solve this?

Common changes required

  • In the Sanction Letter, Key Fact Statement (KFS), and Loan Agreement – please mention that
    • The shown repayment schedule is only an “Indicative Repayment Schedule“
    • Instalment billing would only start after the actual fund transfer, in case of a delay in fund transfer the repayment start date will also be delayed – the revised repayment schedule will be shared post disbursement via SMS/WhatsApp on the registered number
    • The interest will only be charged from the date of the actual fund transfer, hence the adjustment of the broken period will be done either in the first instalment or the last instalment – the same would be visible in the revised repayment schedule shared with the customer
  • Share the revised repayment schedule post-payment
    • Share in the Welcome Letter
    • Share over WhatsApp/SMS/Email
    • Capture a read receipt
  • Automate payments
    • Payment to customers can be automated via Bank API integration / Host 2 host connectivity

Case#1: Simple solution for Online NEFT / RTGS payments based disbursements

  • Keep the file at the disbursement maker stage till all the dependencies are clear
  • Disburse in the system only after making the payments
  • This is a process change and does not require any technology change

Case#2: Disbursement through cheques

  • Disbursement through cheque is quite common in HFCs for purchasing property
  • RBI guidelines mention that “Similarly, in the case of loans being disbursed by cheque, instances were observed where interest was charged from the date of the cheque whereas the cheque was handed over to the customer several days later.”
  • Some HFCs are trying to game the circular by arguing that they can always say they handed over the cheque to the customer on the date of cheque printing. But please note that it will be difficult to justify this if the average time between cheque handover and cheque clearance is significantly more than 3 days.
  • Hence it’s advisable to follow the spirit of the circular

Easy solution

  • Print the cheque only after all the OTCs are cleared
    • Calculate net disbursement amount – broken period adjustment etc only after OTCs are cleared
    • Stop the practice of printing the cheque beforehand
  • Mark the loan as disbursed only when the seller has been handed over the cheque by the lender

Complex solution

  • Suppose for whatever reason, you are not comfortable with the Easy Solution, below is a complex solution that LMS providers can offer

Complex solution: LMS-related changes

  • Introduce a concept of draft loans
    • A loan is a draft loan until the actual payment is made
    • Cheques can be printed – cheque management happens in the LMS
    • The loan number is generated
  • Configuration to rollover repayment start date if payment is not done
    • In the draft stage, LMS should not bill the instalment but auto-roll it over the repayment start date if payment is lying open
  • Configuration to not bill interest if payment is still not done
    • In the draft stage, daily interest accrual should not occur for loans where payment is still pending
  • Configuration to auto-adjust the gap interest (broken period interest)
    • In case the Gap interest (Broken period interest) is deducted from the loan amount, the difference in the interest will be marked as payable and will be automatically adjusted on the next billing date
  • SOA download restrictions
    • In the draft stage, SOA should not be downloadable
  • Refreshing the repayment schedule on the actual payment
    • On converting the draft loan to a disbursed loan, LMS can offer an additional inbuilt rescheduling option – “Redraw repayment schedule from actual payment date”
    • It can take the interest start date as the “Actual payment date”
  • Booking of charges on actual payment
    • If processing fee/insurance premium or any other charges are deducted from the loan amount then the same can also not be booked in the draft stage
    • Hence the booking of such charges can only happen on the date the draft loan is converted to disbursed loans
  • Restriction on auto-posting accounting entries
    • As the loan is in the draft stage, automated posting of accounting entries should be disabled
    • Accounting entries should be posted only when the status changes from draft to disbursed
  • PF and other charge amortisation for IndAS
    • Amortisation of charges should also be restricted in the draft stage
    • The amortisation schedule for fees should be drawn only once the loan is fully disbursed
  • Customer communication
    • Pro-active customer communication can help create confidence with the customer and reduce grievances
  • Special caution for Tranche cases
    • Every LMS implements tranche cases slightly differently.
    • While making changes to the LMS, you need to ensure that the new changes do not interfere with tranche cases

Synoriq LMS: Already offers this functionality

  • The best part about us is our ability to respond to changes fast.
  • We proactively implemented – the “Rescheduling option for interest start date” around 7 months back when we read that Kotak Bank was fined for this reason
  • In terms of features – we are India’s No. 1 LMS option which is New Age + Matured.

Other aspects of the Fair Practice Code?

I will be writing separate articles for the following

  • In the case of disbursal or repayment of loans during the month, some REs were charging interest for the entire month, rather than charging interest only for the period for which the loan was outstanding.
  • In some cases, it was observed that REs were collecting one or more instalments in advance but reckoning the full loan amount for charging interest.