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    While obtaining a business loan, many borrowers may be unaware of foreclosure or pre-payment charges. Also, they often do not know about the Reserve Bank of India’s (RBI) guidelines on foreclosure charges. Hence, this article explains what foreclosure charges are and RBI’s guidelines for the same.

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    RBI guidelines on foreclosure charges for MSMEs

    According to the RBI guidelines introduced in May 2014, it is advised that banks are not allowed to charge foreclosure charges or pre-payment penalties to all floating rate term loans for individual borrowers.

    However, these guidelines are for individual borrowers who have borrowed on a floating rate of interest.

    On the other hand, a media report suggests that during the 27th Standing Advisory Committee of RBI, the central bank of India, clarified that levying pre-payment penalty charges on MSMEs is a violation of the Bank Code for micro and small enterprises (MSEs).

    What are the current foreclosure charges on MSME loans?

    Many banks and NBFCs levy foreclosure charges on the prepayment of a business loan. Most banks and NBFCs charge pre-payment penalties of 2%-5% of the prepayment amount.

    Latest developments: Foreclosure charges for MSMEs

    In 2022, the Federation of Indian Micro and Small Medium Enterprises (FISME) approached the Reserve Bank of India to seek relief against high foreclosure charges.

    In this regard, a few MSMEs had also approached the Banking Ombudsman to seek justice against imposed foreclosure charges.

    After FISME’s letter to the RBI, a few banks have reported to have dropped the foreclosure penalties for MSME borrowers. These banks include IDFC Bank and Karur Vysya Bank Ltd., (KVB).

    Moreover, a media report suggests that the State Bank of India (SBI) has assured its MSME customers that it will not levy any foreclosure charges to its MSME customers. While clearing SBI’s stand, the official said that the bank has laid down instructions for not imposing foreclosure charges or pre-payment penalties on floating term loans approved to MSMEs. This is valid even in cases of takeover of the loan by other financial institutions.

    ICICI Bank also does not charge any prepayment penalties to micro and small enterprises.

    In a nutshell: Can a bank levy a pre-payment charge in case of foreclosure?

    As per the RBI guidelines, banks and NBFCs are not allowed to charge foreclosure charges on loans obtained by individual borrowers on a floating rate of interest.

    On the other hand, the Bank Code for MSEs does not allow banks to impose foreclosure charges on customers falling under the category of MSMEs. In order to get a waiver on foreclosure charges, the borrower should have a Udyam certificate.

    What can you do if your bank imposes foreclosure charges?

    Firstly, you need to ensure that you have MSME or Udyam registration.

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    If the lender is imposing foreclosure charges to prepayment of your business loan, you need to inform them about the RBI guidelines.

    If the lender still refuses to offer a waiver of foreclosure charges for an MSME, you can approach the Banking Ombudsman. The Ombudsman is a senior official who is appointed by the Reserve Bank of India to address customer complaints and grievances.

    Raising a complaint against the imposed foreclosure charges with the Banking Ombudsman

    Here is how you can raise a complaint against imposed pre-payment penalties with the Banking Ombudsman.

    • You can visit the RBI’s website to lodge a complaint.
    • Click on file a complaint.
    • Fill in your details such as name, mobile number, etc. Also, fill in the form that appears on the screen.
    • You will be required to upload proof of the bank refusing to reverse the foreclosure charges.

    Foreclosure charges: What to keep in mind while obtaining a loan?

    Here are some tips for you to avoid disputes with regard to foreclosure charges with your bank or NBFC while obtaining a business loan.

    • For MSMEs, transferring a business loan or foreclosing it becomes difficult due to heavy prepayment charges. Therefore, it is important to learn about foreclosing charges beforehand. Read the business loan agreement carefully to learn about the foreclosure charges.
    • If a clause mentions foreclosure charges, you can negotiate the terms and conditions for the business loan. You can point out that such a clause would be a violation of RBI guidelines for foreclosure charges for MSMEs.
    • You may need to submit your Udyam or MSME registration certificate to get a waiver of foreclosure charges.
    • If there is no mention of foreclosure charges, you can ask questions about the bank’s current practices to the loan officer.
    • Stay updated with the RBI guidelines and government regulations with regard to foreclosure charges. You can also take help of an expert for understanding regulations.

    Frequently asked questions

    What are the current pre-payment penalties on MSME loans?

    While some banks do not impose any foreclosure charges on MSMEs, a few banks continue to do so. In most cases, foreclosure charges are between 2%-5% of the pre-payment amount excluding taxes. You can enquire in your bank about the foreclosure charges before closing or transferring the loan.

    Is it mandatory to pay foreclosing charges?

    It depends on the type of loan. As per the Bank Code for MSMEs, banks can not charge any foreclosure charges on MSME customers.

    Can you avoid foreclosing charges?

    Yes. You need to be careful while signing a business loan agreement with the bank. Read all clauses carefully. Check if the clause of foreclosure charges. If the clause mentions such a clause, you will need to negotiate with the bank.