Welcome to Pioneer Housing Finance Academy
E-1/25, Sector-7, Rohini
Delhi - 110085
011-27043805
phfa2018@gmail.com
Welcome to Pioneer Housing Finance Academy
Delhi - 110085
phfa2018@gmail.com
1. Prepayment penalty or levy or charges or foreclosure charges by whatever name called is a pre-agreed amount between a borrower and a lender which the borrower is required to pay to the Lender in a borrowing arrangement in case the borrower decides to repay the loan before the agreed period. This is to compensate the lender for the loss likely to be suffered by him on account of such pre-payment by the borrower. Though called a ‘penalty’, the amount agreed should be reasonable and of compensatory nature for the loss or damage likely to be suffered by the Lender due to such prepayment by the borrower. In case the amount agreed is unreasonable, it will be regarded as unconscionable contract, liable to be declared unenforceable and void by the Courts.
2. However, there were lot of dissatisfaction and grievance amongst the borrowers particularly in the home loan segment against the home loan providers, may that be a bank or a housing finance company, against such levies. Root cause of such complaints was the unreasonable nature of the amount collected by some of such lenders, which virtually deprived the borrowers to avail loans at lower rates of interest in a falling interest rate scenario. Home loan borrowers getting large amounts at the time of their retirement, inheritance, or sale of some other property etc. also resented payment of such levies, while prepaying their loan obligations. Additionally, with the introduction of fixed and floating rates of interest, it was expected that the lenders also have the opportunity to adjust to the market dynamics in case of pre-payments and should not collect any amount by way of pre-payment penalties.
3. RBI has been considering reasonableness of bank charges from time to time. It had issued a circular dated February 2, 2007 in this context to the Banks. On May 26, 2010, RBI constituted a Committee to look into banking services rendered to retail and small customers and to suggest, inter alia, measures for expeditious resolution of complaints under the Chairmanship of Shri M. Damodaran. The Committee submitted its Report on July 04, 2011. In the said Report, in paragraph 2.3.4, the Committee discussed Home Loan Issues and noted as follows :
4. One of the action point to improve Customer Services of banks decided at the Annual Conference of Banking Ombudsmen held on September 5, 2011, was that Banks must not recover pre-payment charges on floating rate loans. Banks may also offer long term fixed rate housing loans to their customers and address their asset liability mismatch (ALM) issues by recourse to the interest Rate Swaps (IRS) market. Floating rate loans pass on the interest rate risk from banks which are much better placed to manage it to borrowers and, thus banks only substitute interest rate risk with potential credit risk. The bank will, however, be free to recover /charge appropriate pre-payment penalties in the case of fixed rate loans.
5. In its Monetary Policy Statement 2012-13, in paragraphs 81-83, RBI referred to the Damodaran Committee Report and proposed that banks will not be permitted to levy foreclosure charges/prepayment penalties on home loans on floating rate basis. Accordingly, by a circular dated June 5, 2012 RBI directed that the banks will not be permitted to charge foreclosure/ prepayment penalties on home loans on floating rate basis with immediate effect. It may not be out of place to mention here that while the instructions issued by RBI refers to Home Loan on floating rate basis and not to the borrowing entity, the context in which it was issued was only small and retail borrowers.
6. In its first bi-monthly monetary statement of 2014-15 dated April 1, 2014, RBI was of the view that consumer protection is an integral aspect of financial inclusion. By its Circular dated May 7, 2014, following the said Policy Statement, and in the interest of consumers, RBI advised the banks that, they will not be permitted to charge foreclosure charges/prepayment penalties on floating rate term loans sanctioned to individual borrowers with immediate effect. It may be noted that this Circular does not distinguishes between an individual borrower who has obtained term loans for business purposes or otherwise. Thus, earlier restriction of such advisory being only on home loans also was done away with.
7. Vide its circular dated July 14, 2014, RBI advised NBFCs not to charge foreclosure charges/pre-payment penalties on all floating rate term loans sanctioned to individual borrowers, with immediate effect, with a view to bring uniformity with regard to prepayment of various loans by borrowers of banks and NBFCs.
8. National Housing Bank (NHB), the regulator of housing finance companies (HFCs) has also issued instructions on pre-payment penalties from time to time. Vide Circular dated October 18, 2010, NHB advised that pre-payment levy should not be collected from the borrowers when the housing loan is pre-closed by the borrowers out of their own sources. Again on October 19, 2011, NHB advised that HFCs should not charge pre-payment penalty on pre-closure of housing loans under the following situations:
From the above, it can be observed that these instructions will be applicable depending upon the nature of loan and not depending upon the type of borrowers. Therefore, in case a loan is booked as a housing loan in the books a lending HFC, the instruction will become applicable.
9. NHB vide its Circular dated August 14, 2014 again reviewed the instructions on the subject keeping in view the developments in the case of RBI/NBFCs based on the directions issued by RBI. Vide the said Circular, NHB as a measure of customer protection and also in order to bring the uniformity with regard to prepayment of various loans by borrowers of banks, NBFCs and HFCs, advised that HFCs shall not charge foreclosure charges/prepayment penalties on all floating rate term loans sanctioned to individual borrowers. Thus, by the said circular parity was brought in the matter of pre-payment penalty on floating rate term loans to individual borrowers in the financial sector. NHB vide its Circular dated September 3, 2014 clarified that loan in which company, firm, etc. is a borrower or co-borrower is excluded from purview of the Circular dated August 14, 2014. NHB vide its Circular dated July 22, 2016 further clarified as follows:
10. The use of the words “individual borrower” in the circulars issued by RBI in this context was also taken to mean that it excludes proprietary concerns by banks. However, this aspect came to be examined by the Calcutta High Court (Appellate Side) in Devendra Surana Vs. Bank of Baroda & Ors in W.P.No.5521(W) of 2017.Vide its Order dated December 12, 2018, the Hon’ble Court held that “ A natural person and his sole proprietorship firm are the same legal entity. The liability of the sole proprietorship firm, is that of the natural person carrying on business under its name. The sole proprietorship firm of a natural person and the natural person owning the firm do not enjoy the benefit of being treated as separate legal entities. They are one and the same legal entities.”
Thus, what hold good in case of banks also hold good in case of HFCs and to such extent NHB instructions are clearly contrary to the said judgement, more particularly when NHB circular refers to the parity among banks, NBFCs and HFCs in this regard.
11. The use of expressions such as “small and retail borrowers”, “consumers” or “individual borrower” in the Policy Statement, Committee Report or in the Circulars issued by RBI referred as above or protection on interest of individual borrowers in case of circular issued by NHB does give rise to some ambiguity about the true intent and spirit on the issue of restriction on charging of prepayment penalties on floating rate loans by banks, NBFCs and HFCs. It will be in the interest of all i.e. borrowers and lenders, if the position is clarified further by means of a circular/clarification by Reserve Bank of India/National Housing Bank in this regard. This will also avoid unnecessary litigation between the parties.
12. While on this, the position of HUF, which is akin to an individual in this regard also need to be reviewed and going by the spirit of this beneficial measure need to be included as being an entity entitled to such a relief.
13. Another area of review is the joining of co-borrower by the lending institutions. It has been seen that lending institutions add co-borrower to safeguard their interest or to better secure themselves. Where the co-borrower, which is sometime even a partnership firm or a company is not the actual beneficiary and has been added by the lending institution to better secure itself, the individual borrower should continue to get the benefit of not paying any pre-payment penalty on payment of floating rate loan. This will also help the borrowers in securing loans as in the absence of such stipulation and to avoid the regulation of pre-payment penalties, the lending institution will be prompted to insist on addition of a co-borrower, merely to take itself out of the regulation on prepayment penalties.
14. The applicability or non applicability of NHB instructions on fixed rate housing loans paid out of own sources by the borrower also need to be reviewed and if not applicable post parity of the regulation amongst banks, NBFCs and HFCs, in the interest of customers re-introduced early in the interest of customers.
Penalties have been prescribed for non-compliance /breaches /violations of the statutory provisions including regulations, directions, guidelines, orders or circulars etc. issued by RBI/NHB under Section 49 to 52 of the National Housing Bank Act, 1987. The prescribed penalties include imprisonment or fine or both imprisonment and fine. Where the prescribed penalty is imprisonment or both imprisonment and fine, NHB/RBI itself or through its authorized officer is required to approach a Court for imposition of such penalty.
However, NHB/RBI have also been vested with powers to impose fines in terms of Section 52A of the NHB Act in lieu of the above penalties. Paragraph 114.1 of the Directions reiterates this position with regard to the power of NHB/RBI to impose such penalties by way of fines only for which also a procedure is duly prescribed in the statute.
These penal provisions need to be reviewed in totality as there are many aspects some of which are discussed below which needed to be looked into apart from the procedural part.
It is submitted that the procedure laid down under the other statutes governing financial sector Viz., SEBI Act, PFRDA Act etc. needs to be looked into to ensure that there is no scope of arbitrariness and rules of justice & fair play are applied in the matter of imposition of penalties by NHB/RBI under Section 52A of the NHB Act.
The salient features of the provisions of RBI Act and NHB Act which promotes justice and fair play are:
However, compared to SEBI & PFRDA Acts, RBI & NHB Act does not have :
This need to be suitably provided.
As already stated that HFCs are also NBFCs and can be penalized under section 58G of the RBI Act. The prescribed quantum of penalty under the RBI Act and under NHB Act is different, the one under RBI Act being more severe. It is therefore necessary to remove any kind of uncertainty and clarify under which of the Act, RBI will resort to imposition of penalty, if the circumstances so arises.
Section 49(2), 49(2B), 49(2C) & 49(4) also provides for imposition of fines only on the HFC contravening the provisions of the Act/ directions etc. through the Courts. These penalties are much less than the one prescribed under section 52A. This position need to be reconciled and it should be made clear that in no case the pecuniary penalty under section 52A shall exceed the one prescribed under section 49.
A closure look at section 52A also reveal that the provision should have been “ (b) where the contravention or default is under sub-sewhere the contravention orction (2A) or clause (a) or clause (b) of sub-section(3) of section 49….” Instead of “ (b) default is under sub-section (2A) or clause (a) or clause (aa) of sub-section(3) of section 49….”
The unintended mistake has caused immense harm which is evident from the penalties imposed by NHB during the year 2020-21 and even made the 52A(a) absolutely nugatory. In our view, legislature has intended to impose heavy penalties only in cases of (a) where the business is conducted without registration (b) where deposit is received in contravention of any direction and (c) prospectus or advertisement is issued in contravention of any order as is evident from the provision of section 49(3)(a) and (b). Pending amendment to the Act, there is need to ensure that for violation of the provision of clause 49(3)(aa), the penalty is imposed under sub-clause (a) of section 52A(1) and not under sub-clause (b).
Further, the Act also refers to “where such default or contravention is continuing one”, the expression need to be clarified by examples or notes. For instance if a HFC accepts a deposit in contravention of direction, the offence is complete and it is not continuing till the time deposit is repaid warranting imposition of penalty for a continuing offence. In case of breach of a direction, it should constitute as if the offence is complete. However, in practice it is being treated as continuing one and penalties are being applied accordingly.
Limitation. There is no period of limitation prescribed under Section 52A of the NHB Act. Therefore, the period of limitation prescribed under the Code of Criminal procedure (Section 468) shall apply in terms of which the period is six months, if the offence is punishable with fine only. The position need to be clarified suitably both to the Companies as well as officials of the regulatory bodies so that timely action on violations can be initiated. If for any reason it is felt that section 468 is not applicable, then the limitation should be provided in the Act itself. This position should even apply to the offences under the RBI Act.
GST. The position of applicability of GST also need to be clarified as it is seen that NHB has collected GST even on the penalties levied by it which is neither goods nor any services rendered by it attracting the GST Act, while none of the other regulator has made such a collection.
For ease of doing business and bring certainty in the business, it is necessary that decision on regulatory permission/ approvals etc. are taken without undue delay, for which timeline need to be fixed in the Act/ directions. Some of the areas, where such timeline need to be fixed are:
Finance (No. 2) Act, 2019 had integrated the regulatory function of HFC and vested the same in RBI like other NBFCs leaving supervision function with the National Housing Bank. This was a new structure in the financial sector where the regulation is done by the Central Bank and supervision is done by another statutory body.
With the issue of Master Directions with a clear direction (direction 114) that supervision of HFC will rest with NHB, an attempt is made to clarify the position of supervision of HFCs. However, the legal position remain the same i.e. both RBI and NHB has the power of supervision of HFC and thus HFCs are subject to dual supervision, which need to be avoided. In fact, Standing Committee of Parliament has made a specific comment while discussing the proposal for amendment to NHB Act that any kind of duality, whether in the matter of regulation or of supervision, should be avoided.
The above fact is also evident from the fact that approval required in certain matters (for instance acquisition/takeover of control etc) is required to be sought from RBI and not from NHB. RBI internally seeking comments from NHB before granting or refusing such permissions only add to delays in decision making by RBI.
As mentioned supra, RBI can impose penalties on HFCs under RBI Act as also under NHB Act and the two differ from each other. For this reason also there is need to synchronize the provision and vest all such powers in RBI under the RBI Act.
In the ensuing two years, it is seen that RBI has extended many provisions of number of directions which were applicable to NBFCs to HFCs in addition to reiteration of the provisions which were issued by NHB and were applicable to HFCs. However, ensuring compliance of all these provisions vests in NHB. This has given rise to possibility of two approaches being adopted in the matter of enforcement of these directions one by RBI while supervising NBFCs and another by NHB while supervising HFCs. A glaring example is the collection of GST on the penalties levied by NHB while RBI has not charged GST on the penalties levied by it on NBFCs. This need to be avoided and uniform approach need to be adopted.
NHB is also lender to HFCs and the lending has increased overtime. As of date over 60 HFCs are availing refinance from NHB. All these HFCs, which are mainly in the private sector are also availing financial assistance from banks. For the peculiar position enjoyed by NHB, lending by NHB to HFC is considered one of the criteria for financing by other lenders to such HFC. However, in case of some problem or mismanagement of HFCs, NHB is blamed both by the public as also by other lenders. This causes damage to the image of a supervisory authority and to the whole system of supervision in the eyes of public. The DHFL fiasco is a clear example of public perception where despite clear provision and agreements between DHFL and NHB, lenders, depositors and public at large has questioned the action of NHB in the matter of recovery of its dues, being also the supervisor of DHFL.
It may also be mentioned that the regulation of RRBs by RBI and supervision by NABARD stands on a different footing and cannot be treated as a good example of keeping supervision and regulation with two different entities as RRBs are also owned by Central Govt./State Government etc.
For the foregoing reasons, the present arrangement of supervision of HFCs needs to be reviewed at the earliest.
Paragraph 45 of the Master Directions relating to acquisition /transfer of control refer to changes in the shareholding including progressive increases over time. From the current direction it is not clear from which date the same is to be reckoned e.g. from the date of issue of the current direction or from the date on which NHB had issued similar directions.
It is also not clear whether such approval will be required every time once the limit of 10 per cent or 26 per cent is reached OR once HFC has obtained approval, fresh approval will be required only when again there is a change of 10 per cent or 26 per cent as the case may be from the one approved earlier. Similarly, in the case of change of directorship also whether approval is required every time after once there is a change in 30 per cent of the directors excluding independent directors.
We suggest that fresh approval should be mandated only when again there is change of over 10/26 percent in the shareholding or 30% in the directors.
The above positions needs to be suitably clarified to remove uncertainty in this regard.
RBI had issued clarifications from time to time with regards to its directions, guidelines and circulars issued to NBFCs. Many of these circulars, guidelines and directions have now been extended to HFCs. RBI should, therefore, clarify by means of a Circular that all such clarifications issued by it from time to time and applicable to NBFCs shall mutatis mutandis apply to HFCs.
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