RBI Removes Pre-Payment Charges On MSME Loans, NBFCs’ AUM Likely To Take Hit

The Reserve Bank of India (RBI) has directed that from January 1, 2026, lenders will be prohibited from imposing foreclosure or pre-payment charges on floating-rate loans provided to micro, small and medium enterprises (MSMEs). This will apply to all new and renewed loan accounts sanctioned on or after the cut-off date.

The central bank said the directive aims to enhance credit discipline and provide better transparency to borrowers. It is consistent with similar protection that already exists for individual borrowers of floating-rate loans.

NBFCs Can Face 5-25 Per Cent AUM Impact

According to an IIFL Securities report this action by RBI might impact between 5 per cent and 25 per cent of the assets under management (AUM) of non-banking financial companies (NBFCs), depending on the extent of their exposure to floating-rate MSME loans.

Most NBFCs currently levy pre-payment charges ranging from 2-5 per cent on such loans. These charges are particularly levied on products, such as loans against property (LAP) and MSME credit, where early termination of loans is common due to refinancing possibilities.

Revenue from Prepayment Charges May Decline

Pre-payment fees enable lenders to recover operating expenses, while simultaneously balancing revenue, particularly when customers repay early. With the RBI prohibition, NBFCs will not be able to impose these fees on qualifying MSME borrowers from the effective date.  

IIFL report mentions that removal of pre-payment charges may result in higher refinancing turnover, especially in a falling interest rate environment, as customers try to move over to cheaper lenders.

Probable Shift in Market Dynamics

The RBI instruction could result in increased competition among lenders in the MSME loan market. Without pre-payment charges, borrowers would certainly have more choice and freedom to switch to lenders with more favourable terms.

This change could impact retention of loans for NBFCs, especially in segments where customer loyalty is trapped in financial lock-ins rather than pricing or service.

NBFCs Likely to Change Loan Structures

In light of the regulation, NBFCs may consider making changes in their loan products. These could include focusing on fixed-rate loans or offering longer lock-in periods where permitted. A few NBFCs may also take to modifying their fee models to address potential earnings pressure due to declining fee income, says the IIFL report.

Extended Timeline for Implementation

Since the rule will apply only to new and fresh loan accounts from January 1, 2026, NBFCs and other lending institutions will get enough time to analyse their books and make the necessary fine-tuning.

The extended time frame will allow financial institutions to make adequate changes and lenders with a large share of floating-rate MSME loans may start re-calculating plans well in advance.