Part 02 — RBI Regulatory Framework

Conduct Rules

Conduct regulation is where RBI turns a credit product into a borrower-facing obligation. For SME loans, the lender may be free to price for risk, ask for collateral, reject the application or use digital acquisition, but it must disclose the economics, avoid hidden charges, communicate changes, handle complaints, and keep recovery within the code.

Fair Practices Code

Banks and NBFCs must maintain a Fair Practices Code (FPC). In lending operations this means the borrower should know the lender’s identity, the amount sanctioned, rate, tenor, security, processing fees, penal charges, prepayment terms, grievance process and consequences of default. For NBFCs, FPC obligations sit inside the NBFC Scale-Based Regulation framework (RBI NBFC SBR Master Direction, October 19, 2023). For digital loans, the 2025 Digital Lending Directions impose additional disclosure and delivery requirements (RBI Digital Lending Directions, May 8, 2025).

In real SME lending, conduct breaches often look mundane: the sanction letter says 18% but the borrower experiences 26% APR after upfront charges; the DSA promises “no foreclosure charge” but the loan agreement says otherwise; the business owner’s spouse signs as guarantor without understanding liability; a working-capital renewal is delayed and penal charges accrue; or a recovery agent contacts employees/customers of the borrower. These are not merely service issues. They become regulatory and legal risk.

Interest Rate Policy and APR

RBI does not impose a single interest-rate cap for ordinary bank/NBFC SME loans. Instead, the lender’s Board-approved policy should explain how rates are determined: cost of funds, margin, borrower risk grade, collateral, tenor, operating cost, portfolio credit cost, product type and market conditions. For an unsecured GST-surrogate loan, a 20-28% reducing rate may be commercially plausible; for LAP to a prime manufacturer with clean bureau and 50-60% loan-to-value, a similar rate would require stronger explanation.

APR is the borrower-comparable measure. The KFS circular dated April 15, 2024 requires a Key Facts Statement for loans and advances. Digital lending directions incorporate that requirement and require the KFS link in multi-lender offers. For SME systems, APR should be computed from cash flows, not typed manually by sales. Include processing fee, documentation fee, insurance if mandatory, platform fee if charged to borrower, and other upfront costs required for the loan. Exclude avoidable third-party services only where genuinely optional and separately chosen.

Penal Charges: What Changed

RBI issued Fair Lending Practice - Penal Charges in Loan Accounts, August 18, 2023 and later extended the implementation timeline to April 1, 2024 for fresh loans and June 30, 2024 for migration of existing loans where appropriate (extension circular, December 29, 2023). The change was significant: lenders were told not to use “penal interest” added to the interest rate as a revenue enhancer. Penalty for non-compliance with material terms should be levied as “penal charges”, reasonable and proportionate, not capitalised, and disclosed in loan documents, KFS and reminders.

Examples:

Situation	Better conduct treatment
EMI bounce	Fixed or slabbed bounce charge disclosed upfront; do not add 3% p.a. compounding penal interest to principal.
Stock statement delay in CC/OD	Charge as per sanctioned covenant and disclose in renewal letter; do not surprise-bill at year-end.
End-use breach	Treat as covenant breach with recall/repricing rights where contractually valid, not an opaque fee.
Insurance/financial covenant non-compliance	Give cure notice where policy permits; levy only disclosed charges.

KFS and Sanction Letter Discipline

The KFS is not a substitute for a sanction letter. The KFS is the concise economic disclosure; the sanction letter sets product structure, security, guarantors, conditions precedent, covenants, documentation, validity and disbursement terms. In secured SME loans, the sanction letter should specify property/machinery collateral, valuation basis, margin/LTV, insurance, ROC/CERSAI filings where applicable, guarantor obligations and disbursement conditions.

Digital lending adds automatic delivery: digitally signed documents must flow to the borrower’s registered and verified email/SMS once the contract is executed. For assisted journeys, a field agent handing over a printout is not enough unless the system also sends the verified digital pack.

Grievance and Recovery Conduct

RBI’s digital lending direction requires nodal grievance officers at both RE and borrower-facing LSP, complaint facility on the DLA/website, and escalation to RBI’s Complaint Management System/Integrated Ombudsman if rejected, unsatisfactory or unanswered within 30 days (RBI Digital Lending Directions, para 11). Recovery assignment must be communicated to the borrower before the recovery agent contacts them.

SME collections can involve proprietors, partners, directors, guarantors, hypothecated assets and collateral property. Conduct controls should therefore be embedded in the collections system: call-hour guardrails, approved scripts, visit records, agent IDs, promise-to-pay history, complaint flags, do-not-visit notes, settlement approval hierarchy and evidence of notices. See collections compliance for the operational version.