How to Comply with RBI Fair Practices Code for Lending Institutions in India

The Reserve Bank of India (RBI) Fair Practices Code (FPC) establishes a comprehensive framework for ethical lending practices across banks and non-banking financial companies (NBFCs) in India. Originally introduced through the RBI circular dated May 5, 2003, the FPC has undergone significant updates to address evolving challenges in the lending landscape. For lending institutions, compliance with the FPC is not merely a regulatory obligation; it is a cornerstone of responsible financial intermediation.

This practical guide walks lending institutions through the key compliance requirements under the Fair Practices Code, incorporating the latest regulatory developments including the Key Facts Statement (KFS) framework, the revised penal charges regime, and updated pre-payment rules. Whether you operate as a scheduled commercial bank, a small finance bank, or an NBFC, this article will help you build a robust compliance programme.

1. Overview of the Fair Practices Code

The FPC was first introduced by the RBI through its circular dated May 5, 2003, applicable to banks. In 2006, the framework was extended to NBFCs, ensuring that fair lending principles applied across the entire formal lending ecosystem. Today, for NBFCs, the FPC is governed by the Master Direction on Non-Banking Financial Company (Scale Based Regulation) Directions, 2023.

The FPC requires lending institutions to adopt transparent, non-discriminatory, and ethical practices across the entire lending lifecycle, from loan origination through to recovery. It mandates specific obligations regarding:

• Loan application processing and product disclosure

• Communication of terms and conditions to borrowers

• Interest rate transparency and penal charges

• Pre-payment and foreclosure rights

• Non-coercive recovery practices

• Grievance redressal mechanisms

For banks, the directions are incorporated within the Master Directions on Regulatory Framework for Microfinance Loans and other applicable circulars. Every lending institution must adopt a Board-approved Fair Practices Code and ensure its effective implementation across all branches and digital platforms.

2. Loan Application Processing Requirements

Lending institutions must ensure that the loan application process is transparent and borrower-friendly. The key compliance steps are outlined below.

Product Catalogues and Disclosure

Every lending institution must maintain comprehensive product catalogues that clearly describe all lending products offered. These catalogues must include:

• A description of each loan product and its purpose

• Applicable interest rates (whether fixed or floating) and the method of computation

• Processing fees, administrative charges, and any other applicable fees

• Repayment terms, including tenure options and EMI structures

• Eligibility criteria for each product

Designated Staff and Timely Processing

Lending institutions must designate specific staff members responsible for verifying loan applications and communicating with borrowers. The designated staff should be trained to explain product features and terms in a language the borrower understands. Applications must be processed within a reasonable timeframe, and if an application is rejected, the institution must communicate the rejection in writing along with the reasons for rejection.

3. Transparent Communication of Terms

One of the most critical aspects of FPC compliance is the transparent communication of all loan terms to borrowers. The RBI has progressively strengthened these requirements, most recently through the introduction of the Key Facts Statement (KFS).

Key Facts Statement (KFS)

Introduced through the RBI circular RBI/2024-25/30 dated April 15, 2024, the KFS is a standardised document that must be provided to all prospective borrowers before a loan agreement is executed. The KFS must contain:

• The Annual Percentage Rate (APR) of the loan

• All fees and charges, including processing fees, insurance charges, and documentation fees

• The total cost of the loan over its entire tenure

• Details of any variable components and how changes will affect the borrower

• The recovery and penal charges framework

The KFS must be written in simple, clear language. It serves as a single, consolidated reference for borrowers to understand the true cost of their loan, enabling informed decision-making.

Interest Rate and Risk Gradation Disclosure

The method of calculating interest (whether on a reducing balance or flat rate basis) must be clearly communicated. Where risk-based pricing is applied, the institution must disclose the rationale for the risk gradation and how it affects the interest rate offered to the borrower. This transparency ensures that borrowers understand why they have been offered a particular rate and can dispute the classification if warranted.

4. Interest Rate Changes and Penal Charges Framework

The RBI introduced a revised framework for penal charges, effective January 1, 2024. This represents a significant shift in how lending institutions handle borrower defaults and late payments.

Under the revised framework:

• Penalties for default or non-compliance with loan terms must be levied as "penal charges" and not as "penal interest."

• Penal charges must not be capitalised, meaning they cannot be added to the principal outstanding and must not attract further interest.

• The penal charges framework must be clearly communicated to the borrower at the time of loan sanction and must be included in the KFS.

• Any changes to the penal charges structure must be communicated to borrowers with adequate notice.

The RBI introduced this change because the earlier practice of charging penal interest (added to the loan interest rate) resulted in compounding of penalties, creating an unfair burden on borrowers. The new framework ensures that penalties remain proportionate and transparent.

Implementation Steps

• Review and update all loan agreements to replace references to "penal interest" with "penal charges."

• Update internal systems to ensure penal charges are levied as separate line items and are not added to the principal.

• Train front-line staff to explain the penal charges framework to borrowers clearly.

5. Pre-payment and Foreclosure Rights

The RBI has consistently upheld borrowers' right to pre-pay or foreclose their loans. The latest directions, issued on July 2, 2025, and effective from January 1, 2026, further strengthen this right.

• No pre-payment charges or penalties can be levied on floating rate loans, regardless of the loan category or the borrower type.

• For fixed rate loans, pre-payment charges may be levied, but they must be reasonable and clearly disclosed upfront in the loan agreement and the KFS.

• Lending institutions cannot impose conditions that effectively discourage or prevent pre-payment (for example, requiring excessive notice periods or documentation).

Compliance Steps for Pre-payment

• Review all existing loan agreements to ensure compliance with the updated directions.

• Remove any pre-payment penalty clauses on floating rate loans.

• Update internal systems and processes to facilitate seamless pre-payment by borrowers.

• Train staff to assist borrowers seeking pre-payment without imposing informal barriers.

6. Non-Coercive Recovery Practices

The FPC strictly prohibits the use of coercive, intimidating, or unlawful recovery practices. This includes actions by the institution itself and by any third-party recovery agents engaged by the institution.

Prohibited Practices

• Use of physical force, threats, or intimidation against borrowers or their family members

• Contacting borrowers at unreasonable hours (before 8:00 AM or after 7:00 PM)

• Public shaming or disclosure of borrower information to third parties

• Interference with the borrower's right to privacy

• Misrepresentation of the legal consequences of non-payment

Mandatory Safeguards

• All recovery agents must be trained in ethical recovery practices and must carry authorisation letters.

• Borrowers must be informed of the details of the recovery agent assigned to their account.

• Institutions must maintain a supervisory mechanism to monitor recovery agent conduct.

• A dedicated helpline or grievance channel must be available for borrowers to report recovery-related complaints.

7. Grievance Redressal Mechanism

Every lending institution must establish a robust grievance redressal mechanism that allows borrowers to raise and resolve complaints efficiently.

• Every institution must designate a Grievance Redressal Officer and display the officer's contact details prominently at branches and on the institution's website.

• Complaints must be acknowledged within three working days and resolved within 30 days of receipt.

• If a borrower is not satisfied with the resolution, the institution must inform the borrower of their right to escalate the complaint to the RBI Ombudsman under the Integrated Ombudsman Scheme.

• Institutions must maintain records of all complaints received and their resolution status, and these records must be reviewed periodically by the Board or a Board-level committee.

The RBI Integrated Ombudsman Scheme provides a free, accessible, and technology-driven platform for borrowers to escalate unresolved complaints. Lending institutions must not create barriers to this escalation process.

8. KYC Record Uploads to CKYCR

Lending institutions are required to upload customer KYC records to the Central KYC Registry (CKYCR) maintained by the Central Registry of Securitisation Asset Reconstruction and Security Interest of India (CERSAI). This obligation applies to all new accounts as well as to existing accounts when KYC is updated.

• KYC records must be uploaded within the timelines prescribed by the RBI and CERSAI.

• Institutions must verify and update KYC records periodically as per the risk categorisation of the customer.

• Failure to upload KYC records can attract regulatory penalties, as demonstrated in the Bank of Baroda case discussed below.

9. Digital Lending Compliance

With the rapid growth of digital lending in India, the RBI has issued specific guidelines to ensure that digital lending platforms adhere to the same fair practices standards as traditional lending channels.

• All loan disbursals and repayments must be made directly between the borrower's bank account and the regulated entity's bank account, without pass-through or pool accounts.

• The KFS and all loan documentation must be provided to the borrower in electronic form before loan execution.

• The borrower must be given a cooling-off period (also known as a look-up period) during which they can exit the loan without penalty.

• Data collected by digital lending apps must be limited to what is necessary for the loan, and explicit borrower consent must be obtained for any data collection.

• Third-party lending service providers must be disclosed to the borrower, and all communications must clearly identify the regulated entity behind the loan.

The Board of Directors of every lending institution must approve the digital lending policies and ensure that outsourced digital lending activities comply with the FPC and all applicable RBI directions. Institutions that partner with fintech platforms or lending service providers bear full regulatory responsibility for the borrower experience, even when operations are outsourced.

10. Lessons from the Bank of Baroda Penalty Case

The Bank of Baroda penalty case serves as an important reminder of the consequences of non-compliance. The RBI imposed a penalty of Rs 66.7 lakh on the Bank of Baroda for, among other violations:

• Charging interest rates above the contracted rates, in violation of the terms agreed upon with borrowers.

• Failing to upload KYC records to the CKYCR within the prescribed timelines.

Key Takeaways for Lending Institutions

• Ensure that the interest rates actually applied match the rates communicated and contracted with borrowers. Automated systems should be audited regularly to detect discrepancies between contracted and applied rates.

• Prioritise timely uploads of KYC records to the CKYCR. Build automated workflows and monitoring dashboards to track upload compliance and flag delays.

• Treat regulatory inspections and audit observations seriously. Address compliance gaps proactively rather than waiting for enforcement action.

This case underscores that the RBI actively monitors compliance and will not hesitate to impose penalties for violations. A proactive compliance approach, supported by regular internal audits and Board-level oversight, is essential for every lending institution.

Conclusion

Compliance with the RBI Fair Practices Code requires a comprehensive, institution-wide effort spanning policy design, system implementation, staff training, and ongoing monitoring. Lending institutions should treat the FPC not as a checklist, but as the foundation of their relationship with borrowers.

By implementing the measures outlined in this guide (from transparent product disclosure and KFS compliance to ethical recovery practices and timely KYC uploads), banks and NBFCs can build sustainable lending practices that protect borrowers, minimise regulatory risk, and strengthen institutional credibility. With the regulatory landscape continuing to evolve, institutions that invest in robust FPC compliance frameworks today will be best positioned to adapt to future changes.

For institution-specific guidance on building or strengthening your FPC compliance framework, consider engaging qualified legal professionals with expertise in banking and financial regulation.