Introduction
On XX, 2026, the Reserve Bank of India (“RBI“) released the draft Reserve Bank of India (Interest Rates on Loans and Advances) Directions, 2026 (“Draft Directions” or “2026 Directions“) for public comments. This is a significant regulatory development, as it proposes to consolidate and harmonise the interest rate framework applicable across the entire spectrum of Regulated Entities (“REs“) — Commercial Banks, Regional Rural Banks (“RRBs“), Urban Co-operative Banks (“UCBs“), Rural Co-operative Banks (“RCBs“), All-India Financial Institutions (“AIFIs“), and Non-Banking Financial Companies (“NBFCs“) including Housing Finance Companies — into a single, unified set of Directions.
Once notified in final form, the 2026 Directions will replace six existing sets of Directions/paragraphs presently governing interest rates on advances for different categories of REs (listed in Annex II of the draft), thereby creating one composite rulebook in place of a fragmented regulatory landscape.
This article undertakes a detailed, provision-by-provision analysis of the Draft Directions, examines their practical and compliance implications for REs, and highlights the key action points that Boards, Risk, Compliance, and Business teams should begin preparing for even at the draft stage.
At Lal Ghai & Associates, we regularly advise Commercial Banks, NBFCs, Housing Finance Companies, and Co-operative Banks on RBI regulatory compliance, policy formulation, and Board-level governance matters. This article is intended to assist REs and other stakeholders in understanding the proposed framework and its downstream implications.
1. Legal Basis, Commencement and Applicability
1.1 Enabling Provisions
The Draft Directions are proposed to be issued in exercise of powers conferred, inter alia, under:
| Enabling Statute | Relevant Provision |
| Banking Regulation Act, 1949 | Section 21, read with Sections 56 and 35A |
| Reserve Bank of India Act, 1934 | Sections 45JA, 45L and 45M |
| National Housing Bank Act, 1987 | Sections 30A and 32 |
| Factoring Regulation Act, 2011 | Section 6 |
1.2 Short Title and Commencement
The Directions shall be called the Reserve Bank of India (Interest Rates on Loans and Advances) Directions, 2026, and are proposed to come into effect from April 1, 2027 — giving REs a lead time of roughly one financial year (from the date of the final notification) to align their systems, policies, and loan documentation.
1.3 Entities Covered
| S. No. | Category of RE | Statutory Basis for Definition |
| 1 | Commercial Banks (incl. Small Finance Banks and Local Area Banks), corresponding new banks, and SBI | Section 5(c), 5(da), 5(nc), Banking Regulation Act, 1949 |
| 2 | Regional Rural Banks (RRBs) | Section 5(ja), Banking Regulation Act, 1949 |
| 3 | Urban Co-operative Banks (UCBs) | Section 5(ccv) read with Section 56, Banking Regulation Act, 1949 |
| 4 | Rural Co-operative Banks (RCBs) — State Co-operative Banks and Central Co-operative Banks | National Bank for Agriculture and Rural Development Act, 1981 |
| 5 | All-India Financial Institutions (AIFIs) — EXIM Bank, NABARD, NaBFID, NHB, SIDBI | — |
| 6 | Non-Banking Financial Companies (NBFCs), including Housing Finance Companies | — |
Practical Note: The consolidation of six entity-specific Directions into one is a welcome move from a regulatory-clarity standpoint, but it also means that REs must now carefully identify which paragraphs carry entity-specific carve-outs or thresholds (for example, the ₹1,000 crore deposit threshold for RCBs, or the Tier-wise dispensations for UCBs, discussed later in this article) rather than assuming uniform applicability across the board.
2. Key Definitions
The Draft Directions introduce/restate several defined terms that are foundational to the entire framework. These are summarised below:
| Term | Meaning under the Draft Directions |
| Benchmark | The reference rate used to determine the interest rate on a loan or advance |
| External Benchmark | An externally determined reference rate — RBI policy Repo Rate, GoI Treasury Bill yields, Secured Overnight Rupee Rate (SORR), or any other rate published by Financial Benchmarks India Pvt. Ltd. (FBIL) |
| Internal Benchmark | A reference rate determined internally by the RE, in terms of these Directions |
| Fixed Rate Loan | A loan on which the interest rate is fixed for the entire tenor |
| Floating Rate Loan | A loan in which the interest rate changes primarily due to resets in the benchmark |
| Reset | The periodic revision of the interest rate on a floating rate loan, due to benchmark changes |
| Rests | The periodicity of charging interest to borrowers |
| Spread | The mark-up added to the benchmark to account for costs and risk premia; excludes any charges or fees |
| Microfinance Loan | As defined under RBI (Commercial Banks – Credit Facilities) Directions, 2025 (or corresponding Directions for other REs) |
| Personal Loans | As defined under Banking Statistics I (Harmonised Definitions) |
| MSMEs | As defined under the MSMED Act, 2006, as amended |
All other expressions not defined in the Draft Directions take their meaning from the Banking Regulation Act, 1949, the RBI Act, 1934, or common commercial parlance.
3. Governance: The Board-Approved Interest Rate Policy
Paragraph 5 mandates that every RE shall have a comprehensive, Board-approved policy on interest rates on loans and advances (or approved by a Board committee with delegated powers). The policy must, at a minimum, address:
- The methodology for determining interest rates, including the internal benchmark;
- The components of the spread;
- Loan categories; and
- Delegation of powers for loan pricing.
The policy is required to be reviewed at least annually, placing a recurring governance obligation on the Board/Board Committee.
Advisory Note: REs that do not currently maintain a single, consolidated Board-approved interest rate policy — or whose existing policy predates recent RBI harmonisation exercises — will need a fresh policy drafting or review exercise before the effective date. This is an area where Company Secretaries and compliance advisors typically assist in drafting Board notes, policy documents, and minutes recording Board approval.
4. The Interest Rate Framework: General Guidelines
4.1 Fixed or Floating, at RE's Discretion
REs may offer loans at fixed or floating rates. Where a loan has a hybrid structure (fixed for a defined period, floating thereafter, or vice versa), the fixed-rate provisions apply during the fixed period and the floating-rate provisions apply during the floating period — a clarification that removes ambiguity for structured/hybrid-rate products.
4.2 Rests and Compounding
| Loan Category | Rest Periodicity |
| General advances | Monthly rests |
| Agricultural advances — long duration crop | Annual rests |
| Agricultural advances — short duration crop | Based on repayment due date(s), aligned to crop season |
Importantly, for agricultural advances, interest shall be compounded only after the repayment becomes overdue — i.e., simple interest applies until the due date, and compounding kicks in only on default. This is a significant borrower-protection feature that agricultural lenders will need to build into their loan management systems.
4.3 Computation Methodology
- Interest must be computed on a daily reducing balance basis; and
- The Actual/Actual day count convention shall be followed for interest computation.
This standardises computation methodology across all REs and eliminates variance arising from different day-count conventions (e.g., 30/360 vs Actual/365) that some REs may currently follow.
4.4 APR Ceiling for Microfinance and Small-Value Loans
REs must explicitly cap the Annual Percentage Rate (APR) — inclusive of interest and all other charges/fees — on:
- Microfinance loans; and
- Small value loans, defined as a personal loan to an individual where the principal does not exceed ₹50,000.
The APR shall carry the same meaning as under the RBI (Commercial Banks – Responsible Business Conduct) Directions, 2025 (or corresponding Directions for other REs), and must not be usurious.
4.5 Interest Cap for Short-Term Agricultural Loans
For short-term agricultural loans and advances to small and marginal farmers (original tenor up to one year), the total interest and all other charges/fees shall not exceed the principal amount — a hard cap intended to prevent debt-trap situations in the agricultural lending segment.
5. Interest Rate Determination — Chapter III in Detail
5.1 Common Principles for Fixed and Floating Rate Loans
Both fixed and floating rate loans must be priced with reference to an internal or external benchmark, plus a risk-based spread. Critically, no RE may price a loan below the applicable benchmark — this is a floor-pricing rule that applies uniformly, and prevents REs from offering below-benchmark “teaser” pricing that undercuts the very benchmark meant to reflect the cost of funds/market rate.
5.2 Floating Rate Loans — Reset Mechanics
| Requirement | Detail |
| Disclosure | Benchmark used, reset periodicity, and reset date must be explicitly specified in the loan agreement |
| Maximum reset periodicity | Not exceeding 3 months, and once fixed for a loan, must remain unchanged for the loan’s entire tenor |
| Exemption from 3-month cap | RCBs with total deposits up to ₹1,000 crore; NBFCs in the Base Layer; UCBs in Tier 1 and Tier 2 |
| Reset date (periodicity < 1 month) | Reset on the due date as per the loan agreement |
| Reset date (other cases) | Reset on the first calendar day of the month in which reset is due |
| Agricultural loans/advances | Reset periodicity linked to crop season, but not exceeding 12 months |
5.3 Internal Benchmark — MCLR Framework
For Commercial Banks, RRBs, UCBs in Tier 3 & 4, and RCBs with total deposits exceeding ₹1,000 crore, the internal benchmark must be based on the marginal cost of funds, with the resultant rate termed the Marginal Cost based Lending Rate (MCLR).
Computation Methodology (Annex I):
The marginal cost of funds is a moving average of the marginal cost of domestic deposits and borrowings over the trailing 3-month period, computed as follows:
| Step | Description | Formula |
| A | Total fresh deposits raised during the month | — |
| B | Total fresh borrowings raised during the month | — |
| C | Interest expended on (A) during the month | — |
| D | Interest expended on (B) during the month | — |
| E | Cost of deposits | E = C ÷ A |
| F | Cost of borrowings | F = D ÷ B |
| G | Annualised weighted average cost of funds for the month | G = [(E × A/(A+B)) + (F × B/(A+B))] × 12 |
| — | Marginal Cost of Funds | Average of G for the current month and the preceding two months |
Illustrative example from Annex I: With fresh deposits of ₹900 (interest expended ₹3) and fresh borrowings of ₹100 (interest expended ₹0.4), the annualised weighted average cost of funds for the month works out to 4.04%. The final Marginal Cost of Funds figure is the 3-month rolling average of this monthly figure.
The computation must be system-generated and independently verifiable — a requirement that has direct implications for the MIS/core-banking systems used by REs to compute and audit MCLR.
Other REs (not falling in the above category) may determine their internal benchmark based on marginal cost of funds, following a methodology documented in their own policy. In all cases:
- The internal benchmark must be published on the first calendar day of each month (for the MCLR-mandated category) and applies to all loans sanctioned that month linked to it; and
- The methodology for determining the internal benchmark must be publicly disclosed — on the RE’s website/mobile app, or, absent a digital interface, at its branches/outlets.
5.4 External Benchmark Requirement
| RE Category | External Benchmark Linkage for Floating Rate Personal Loans and MSME Loans |
| Commercial Banks | Mandatory |
| RRBs, UCBs, RCBs, NBFCs, AIFIs | Optional / discretionary |
Commercial banks retain discretion to extend external-benchmark-linked loans to other borrower categories as well, if they so choose.
5.5 Spread — Composition and Revision Restrictions
The spread must be determined per the RE’s Board-approved policy and comprises the Credit Risk Premium (CRP) plus one or more of the following illustrative components:
| Spread Component | What It Represents |
| Credit Risk Premium (CRP) | Borrower/facility credit risk — based on credit rating/scoring, probability of default, expected loss, collateral, and other mitigants. Must always be positive; cannot be zero. |
| Operating Cost | Costs of resource-raising, loan origination, servicing, and administration |
| Term Premium | Premium linked to the loan’s tenor |
| Business Strategy Premium | Competitive positioning, liquidity, expected returns, and other commercial considerations |
Key restrictions on spread revision:
- CRP may be revised only upon a documented change in the borrower’s credit profile, following a comprehensive credit-risk review.
- Non-CRP components of the spread cannot be revised for at least 3 years for a floating rate loan (reckoned from first disbursement or the last revision date, whichever is later) — except that a RE may reduce such components earlier, for customer retention, on a justifiable and non-discriminatory basis, per its policy.
- This 3-year lock-in does not apply to RCBs with total deposits up to ₹1,000 crore, NBFCs in the Base Layer, and UCBs in Tier 1 and Tier 2.
Practical implication: This effectively curtails REs’ ability to opportunistically widen spreads on existing floating-rate borrowers (a practice sometimes seen where the benchmark falls but the RE’s effective spread quietly rises). REs will need to build spread-revision audit trails into their loan management systems to demonstrate compliance with the 3-year lock-in and the “credit-profile-change” trigger for CRP revisions.
6. Special Cases (Chapter IV, Part A)
| Scenario | Treatment under the Draft Directions |
| Working Capital Demand Loans (WCDLs) | Each drawdown with a fixed tenor may be treated as a separate loan for interest rate/spread determination |
| Transfer of Loan Exposure — same lender of record | Interest rate (benchmark, spread, reset mechanism) continues as per the transferor-borrower contractual terms |
| Transfer of Loan Exposure — new agreement with transferee | Interest rate governed by the transferee’s own interest rate framework |
| Co-lending Arrangements | RE must additionally comply with RBI (Commercial Banks – Transfer and Distribution of Credit Risk) Directions, 2025 (or corresponding Directions) |
| Foreign Currency Loans | Interest rate determined per RE policy, referencing a market-determined external benchmark plus risk-based spread |
| Acquisition/Merger/Amalgamation | Transferee RE must undertake a one-time mapping of transferred loans to its own interest rate framework, without disadvantaging the borrower (revised rate cannot exceed the pre-merger applicable rate) |
7. Transition Provisions (Chapter IV, Part B)
This is one of the most operationally significant sections for existing REs:
- All existing loans/advances linked to any internal or external benchmark must be migrated to the new framework by April 1, 2029 — through a one-time mapping exercise, conducted with borrower consent.
- The migration cannot disadvantage the borrower: the revised interest rate must not exceed what was applicable immediately before migration.
- No charges may be levied on borrowers for such migration.
- If a benchmark is discontinued mid-tenor of a floating rate loan, the RE must substitute the benchmark without disadvantaging the borrower, and may build a fallback mechanism into the loan agreement to pre-empt such contingencies.
Practical Note: REs should proactively review existing loan agreement templates to insert benchmark-discontinuation fallback clauses, rather than waiting for a benchmark discontinuation event to force reactive documentation changes. Given the migration must be borrower-consented, REs with large legacy retail/MSME portfolios should begin planning consent-collection mechanisms (digital consent via net-banking/app, physical consent letters, etc.) well ahead of the 2029 deadline.
8. Exemptions (Chapter V)
The following categories of loans/advances are exempted from the Draft Directions altogether:
- Loans/advances under Government of India or Government Undertaking schemes (including refinance schemes) with prescribed interest rates;
- Loans/advances sanctioned under a resolution plan;
- Lending in the Term Money market;
- Advances against the RE’s own Rupee/FCNR(B) term deposits (borrower, partnership firm via partner, proprietary concern via proprietor, or guardian-on-behalf-of-ward, as applicable);
- Advances to the RE’s employees, including retired employees; and
- Advances to the RE’s CEO/Whole-Time Director(s).
9. Repeal and Savings (Chapter VI)
Upon notification, the 2026 Directions will repeal the following existing Directions (Annex II):
| S. No. | Direction Being Repealed |
| 1 | RBI (Commercial Banks – Interest Rates on Advances) Directions, 2025 |
| 2 | RBI (Small Finance Banks – Interest Rates on Advances) Directions, 2025 |
| 3 | RBI (Local Area Banks – Interest Rates on Advances) Directions, 2025 |
| 4 | RBI (Urban Co-operative Banks – Interest Rates on Advances) Directions, 2025 |
| 5 | RBI (Rural Co-operative Banks – Interest Rates on Advances) Directions, 2025 |
| 6 | Paragraphs 60 and 61 of RBI (Non-Banking Financial Companies – Credit Facilities) Directions, 2025 |
Standard savings provisions apply — actions, approvals, penalties, and legal proceedings under the repealed Directions continue to be governed by those Directions notwithstanding the repeal, and the Directions operate in addition to (not in derogation of) other applicable laws. The RBI retains final interpretative authority over the 2026 Directions.
10. Compliance Action Points for Regulated Entities
| Action Area | Suggested Steps |
| Board Policy | Draft/revise the Board-approved Interest Rate Policy covering methodology, internal benchmark, spread components, loan categories, and delegation matrix |
| Systems | Assess core banking/LOS/LMS system capability for: daily reducing balance computation, Actual/Actual day-count, system-generated MCLR computation, and spread-revision audit trails |
| Loan Documentation | Update loan agreement templates to explicitly disclose benchmark, reset periodicity, reset date, and to include fallback clauses for benchmark discontinuation |
| Pricing Governance | Build controls to ensure no loan is priced below the applicable benchmark, and that CRP/non-CRP spread revisions follow the prescribed triggers and 3-year lock-in |
| Disclosure | Ensure internal benchmark methodology and monthly benchmark publication are disclosed on the website/app, or at branches where no digital interface exists |
| Migration Planning | Begin planning the one-time borrower-consented migration of legacy loans to the new framework, targeting completion well ahead of April 1, 2029 |
| Tier/Threshold Mapping | Identify which entity-specific exemptions (RCB ₹1,000 crore threshold; UCB Tier 1/2 vs Tier 3/4; NBFC Base Layer) apply to the RE, to correctly scope compliance obligations |
| Regulatory Submission | Evaluate whether to submit comments/representations to RBI during the draft consultation window |
Conclusion
The Draft RBI (Interest Rates on Loans and Advances) Directions, 2026 represent a consolidation exercise of considerable scale — bringing Commercial Banks, Co-operative Banks, RRBs, AIFIs, and NBFCs under one unified interest rate rulebook, while still preserving proportionate relaxations for smaller/lower-tier entities. For REs, the transition period between the final notification and the April 1, 2027 effective date (and the further transition runway to April 1, 2029 for legacy loan migration) should be used proactively — for Board policy revision, system readiness, loan documentation updates, and pricing governance controls — rather than being treated as a compliance exercise to be undertaken closer to the deadline.
Lal Ghai & Associates, Company Secretaries, assists Commercial Banks, NBFCs, Housing Finance Companies, and Co-operative Banks with RBI regulatory compliance advisory, Board policy drafting, and related corporate law and secretarial services. For assistance with aligning your organisation’s interest rate policy and loan documentation with the 2026 Directions, please get in touch with us through www.lgassociates.org.
Disclaimer: This article is prepared for general informational purposes based on the draft Directions issued by the Reserve Bank of India for public comments, and does not constitute legal or professional advice. The final Directions, when notified, may differ from the draft discussed herein. Readers are advised to consult their professional advisors before acting on any information contained in this article.