The Reserve Bank of India (RBI) has initiated a definitive step towards greater transparency in the lending processes of banks and other regulated entities (REs). In a significant move that will affect retail and micro, small, and medium enterprise (MSME) borrowers, the RBI released a directive on Monday mandating the issuance of a detailed Key Facts Statement (KFS) to prospective loan customers, effective as of October 1.
In its efforts to empower borrowers, the RBI aims to diminish information asymmetry and bring clarity to the financial products available in the market. Through a comprehensive circular, the RBI has outlined the key components of a loan agreement and the standard of communication expected between lenders and borrowers. To ensure that borrowers can make informed financial decisions, the RBI has meticulously defined the following terms:
(a) “Key Facts” are the essential, legally significant tenets of a loan agreement, crucial in aiding a borrower’s decision-making.
(b) A “Key Facts Statement” (KFS) is an intelligible summary of these facts, provided in a standardized form.
(c) The “Annual Percentage Rate” (APR) represents the annual credit cost, amalgamating the interest rate and all associated charges.
(d) “Equated Periodic Instalment” (EPI), or EMI when paid monthly, refers to the structured repayments that lead to the full amortization of the loan.
Henceforth, the RBI stipulates that all REs must provide a KFS in clear language, containing the details outlined in Annex A of the circular. Prospective borrowers should not only receive but also acknowledge their understanding of these details, ensuring a transparent transaction.
Delving into specifics, the KFS must have a unique identifier and remain valid for a minimum of three working days for loan tenors of seven days or upwards, and one working day for loans below seven days. Moreover, it will feature an APR computation sheet and an amortization schedule, with Annexes B and C offering hypothetical examples for calculating the APR and disclosing repayment schedules.
Unveiling hidden costs, the APR will encapsulate all RE-imposed charges, including costs recovered for third-party services like insurance and legal fees. It is mandated that the said charges be individually disclosed, and all corresponding receipts and documents be furnished to the borrower timely.
The guidelines also include a provision that prohibits REs from imposing any fees or charges not explicitly mentioned in the KFS unless the borrower consents. The importance of the KFS is further emphasized by its integration as a summary box within the loan agreement, offering a concise view of the terms agreed upon.
Within this framework, credit card receivables are noted as an exception and are thus not bound by these stipulations.
Looking ahead, the RBI expects regulated entities to gear up their systems promptly to adhere to these guidelines. By October 1, 2024, all new retail and MSME term loans, including additional funding for existing borrowers, should fully align with these directives, signifying an unyielding shift towards better-informed and fairer financing.
This measure resonates with the broader RBI endeavor to foster transparent and ethically governed financial practices. The mandatory disclosure of loan specifics ahead of contract execution reduces the risk of unpleasant financial surprises for borrowers. The long-term impact of this policy will likely usher a wave of heightened borrower confidence and an increase in prudent lending activities, with potential transformative effects on the lending landscape.
