The story so far: A regulatory tightrope walk
For years, banks in India routinely imposed penal interest ranging from 1% to 3% on loans and advances. This charge kicked in if borrowers delayed repaying instalments, interest, or EMIs (equated monthly instalments), or failed to meet the terms and conditions of their credit facilities. Essentially, it was a tool for banks to boost their income.
However, the Reserve Bank of India (RBI) recognised this practice was problematic. Believing banks were misusing penal interest, RBI, through its Fair Practice Code, directed them to stop collecting penal interest. Instead, banks were permitted to levy only penal charges. Crucially, these charges were to be a one-time levy and not result in compounding interest.
Despite these good intentions, issues quickly surfaced, as highlighted by Moneylife in earlier articles
These articles specifically pointed out a major flaw: banks were levying an 18% goods and services tax (GST) on these ‘penal charges’. This was a clear violation of the GST Act, as later clarified by the central board of indirect taxes & customs (CBIC). It was also argued that RBI, as the banking regulator, should protect consumer interests by mandating banks to refund this wrongly collected GST, effective from 1 April 2024, until their core banking software (CBS) was updated.
The shocking reality: Banks drag their feet on refunds
To follow up on this critical issue, Right to Information (RTI) applications were filed with all public sector banks (PSBs), posing direct questions:
- When did the bank stop levying 18% GST on penal charges?
- What was the total amount of GST wrongly collected from 1 April 2024, until the date of stoppage?
- Has the bank refunded this GST amount to customers, and, if so, what is the quantum of the refund?
The responses are, frankly, shocking.
Here is a snapshot of the data received from various PSBs:
Here's a quick breakdown of the findings:
- Information blackout: Two banks flat-out refused to disclose any information, including when they stopped collecting GST. They cited exemption under Section 8(1)(d) of the RTI Act, claiming the information involves commercial confidence.
- Partial disclosure: Three banks only provided the date from which they stopped GST collection, withholding details on the amount collected.
- Quantified collections: Seven banks did provide the quantum of GST wrongly collected from 1 April 2024, until their software was modified. The total from these seven banks alone stands at a staggering Rs468.55 crore!
- Minimal refunds: Only two banks have initiated the refund process. Bank of Baroda has refunded an impressive 93% (Rs66.29 crore) of the wrongly collected amount, while Central Bank of India has refunded a mere 20% (Rs7.21 crore).
- The 'remitted to government' excuse: Most banks cited that the collected GST had already been remitted to the government, implying they could not refund it to customers. This excuse, however, flies in the face of existing GST provisions.
Law on refunds: No room for excuses
The GST Act, specifically Section 54(8)(e), clearly states that if an unregistered person has borne the tax incidence, any resultant refund must be paid directly to them, not credited to the Consumer Welfare Fund. This is crucial because while GST-registered businesses (B2B) can claim input tax credit, a massive segment of unregistered individual customers – those with home loans, personal loans, or even small business loans – have no way to recover this erroneous GST levy. They have directly suffered financial losses.
Bank of Baroda's precedent: Why not others?
The fact that Bank of Baroda successfully collected Rs71.13 crore and refunded Rs66.29 crore between 1 April 2024, and 31 January 2025, is a powerful precedent. This clearly demonstrates the feasibility and scale of such refunds. This begs the critical question: If one public sector bank can manage it, why are others not following suit? Are they waiting for explicit directives from CBIC or RBI?
Root cause: Regulatory blunder and compliance oversight
The core of this problem stems from a systemic failure. Banks had long sought clarification from the RBI regarding GST applicability on penal charges. Shockingly, RBI, in its FAQs, (Reserve Bank of India) shirked its responsibility, deferring to the CBIC and effectively abandoning its role in providing clear guidance. This regulatory vacuum contributed directly to banks levying incorrect GST.
Further compounding this issue is the profound failure of chief compliance officers (CCOs) at these banks. Despite their critical role in ensuring adherence to laws and mitigating risks, they failed to prevent the initial collection of erroneous GST and have, since, shown inaction in ensuring prompt refunds. This highlights a severe lapse in compliance oversight across the sector.
RBI’s role: Apathy or action?
Despite its own guidelines mandating banks to reverse erroneous debits and compensate customers for financial losses promptly, RBI has largely remained passive. An escalation in the present issue with RBI's consumer education and protection cell (CEPC) in one of its regional offices revealed a 'post-office' approach; they merely forwarded complaints to the bank and relayed the bank’s reply—without proactively escalating the widespread issue to higher departments (DoS and DoR) within RBI. This inaction suggests a failure to grasp their fundamental role in protecting consumers.
Unseen Iceberg: Private and cooperative banks
The issue's true scale is likely far larger than revealed by our RTI findings which only cover public sector banks. If seven PSBs alone wrongly collected Rs468.55 crore in GST, the total amount across the entire banking sector, including private and cooperative banks (which are not subject to RTI), could easily exceed Rs1,000 crore. This vast, un-refunded sum underscores the urgent need for decisive action.
Time for action: No more delays!
The sheer amount involved is substantial, affecting a vast number of customers across the nation. This is a matter of considerable public interest. As the saying goes, "Justice delayed is justice denied." It is high time for both RBI and CBIC to wake up and issue clear, unequivocal directives to all banks, instructing them to refund every penny of the wrongly collected GST to their customers without further delay.
What are your thoughts on how consumers can push for these refunds?
You may also want to read...
(Chandramouli Mohan retired as a senior manager from a public sector bank after 38 years of service in various capacities in several places across the country. He has been an RTI and consumer activist since his retirement in March 2020.)
1. Banks are not authorized to levy "penal interest" -they can only collect "penal charges". If the directive by RBI is very clear on this, why banks are collecting such penal interest. In fact all banks collect penal interest routinely and that it is written in their loan agreements also very clealry.
2. RBI is right in informing banks that the onus of whether GST is applicable on penal charges or not, lies with CBIC and definitely not RBI. It is not RBI's domain to make judgmental call on CBIC matters.
1. If any customer finds that his loan is debited with penal interest instead of penal charges, he can approach Ombudsman.
2. CBIC has since given clarification. Now is it not the responsibility of the Regulator to ensure banks cease to levy GST? and is it not the duty of Consumer Education and Protection Dept to ensure refund and protect the consumers?