Waiver: Who is Trying To Save Who?

India created a ‘so far, so good’ situation by taking care of the loan interest payments due every month by announcing the moratorium. Borrowers sighed in relief as it free them from the financial crunch from March to May, and extended it again till 31 st August 2020. A cold tension arose as the moratorium was about to end. Following the request for extension of the moratorium, people filed petitions not to apply interest on the EMIs. Typically, a loan moratorium refers to a temporary suspension of interest and principal payments liable to the authority. However, it does not entertain the waiving of due payments for the respective period. So as it is, the borrowers who availed this facility are obligated to pay interest for the deferred EMIs. Since it would be an additional brunt to the people, the Supreme Court (SC) asked to ease the borrowers from this, as it would defeat the purpose of the relief. The SC examined several hearings on the interest cancellation plea for more than a month. The government, nevertheless, backed the RBI that a blanket waiver across all loans would affect the financial stability of the banks.


However, the centre, by October, decided to support waiving the compounding interests on the moratorium dues. The SC also wanted the centre to consider all the borrowers from various sectors for the relief. Given that specific financial packages have been released to gear up the industries, the centre refused to think about it, as it puts the banks in an uncertain position. The banks felt relaxed when the government announced that it would take responsibility for waiving the compounding interest on the instalments for the active retail and MSME loans during the moratorium period.


Post the verdict the centre stated that it would credit the borrowers account for the amount of interest paid by certain people irrespective of the pandemic, for people who enjoyed the convenience of the moratorium, and especially for the case of compounding the deferred interest accumulated for the time. The government systematised the banking system to approach the State Bank of India as the nodal bank to transfer the difference between the compound and simple interests for the six months for the loan amount of 2 crores by 5th November.


How does the government reimburse the amount to the borrowers’ account?


The government gave the actual amount by differencing the compound interest from simple interest. Let’s take an example, D has an outstanding loan of 50 lakhs at a 10% interest rate (for simple calculation purposes). In this case, D does not pay back the principal amount.

Source: CapitalMind


From the table, Mr D has to pay a monthly interest of 41,667. Due to the pandemic, the RBI offered a moratorium on interest payments for six months. If D has availed this aid from the second month, then D’s interest payment is accumulated with the monthly interest and hence, the principal as of the second-month increases to 50,83,681. The same principle applies until the sixth month and gives the compounded interest. Therefore, in this example, the government pays Rs 5267 to D. Nevertheless, D has to pay the simple interest of Rs 250000 to the banks.


Another example will imply the real situation of the Ex Gratia payment. Consider an individual X who has taken a home loan of 2 crores at 8 % for 20 years. So, X has to pay a monthly interest of Rs 1.33 lakh at 0.67 per cent (8% divided by 12 months). Having X used the moratorium, the outstanding loan at the end of the first month would be 2.013 crores. The interest on interest mechanism inflates the total payable loan to Rs 2.081 crores at the end of the sixth month. It is Rs 8.134 lakhs more than the principal, while the simple interest amounts to just Rs 8 lakhs. Therefore, the six-month compound interest is Rs 13452, and it is Rs 2242 per month, which will be rendered by the government.


The interest payments may vary as for the change in interest rates. But the question is, are the MSMEs not in a position to pay this? Though this may have caught everyone’s mind, the pandemic dented multiple businesses in varied sectors, which have led to the desperate need to reduce the burden.


What’s the reason behind the compromise?


The government cannot drag the banks into this mess, as they have a high likelihood of dealing with bad loans in the futurity. The moratorium has already brought quite a havoc to the banking functions, as it meddles with the interest payments to the depositors, who are the primary money creators of the banks. They have also provided an option to restructure the loans which spread the systemic risk for a longer time. Considering that the major chunk of moratorium loans are the retail and MSME loans which often fall on the brink of the default and having the banks involved in this issue could suffocate the sector, the government came to the rescue.


What’s the cost to the government?


It must empty nearly 7500-8000 crores from its fiscal. Moreover, waiving the interest on the deferred EMIs violates the canons of public finance as it would be unfair to those who repaid as per schedule. Besides, it must have incurred the compliance costs for making these payments. The money it had put in this process would have been used for several other reasons even though it might seem the smallest hit to the centre. Unless the government has spent the expenditure, it wouldn’t be a stimulus to the economy. Now, the government has to look at other ways to recover the money, which may come back in the form of taxes in the future. The ultimate irony is that the media referred to the ex gratia as a Diwali gift to the people. The whole issue raised by petitioners had made the centre, SC and banks find themselves in an embarrassing situation which gave them no unanimous way to settle with the public’s opinion.


From an ordinary person point of view:


A substantial portion of deposits is from upper-middle-class and a quarter from middle and lower-middle classes. So, it is imbecile to state that people are living off only from the interest money except for the low-income earners. If RBI had announced a recess on depositor interest payments along with a permanent moratorium on EMIs, the centre and banks could not have fiddled around in the case of waiving compounded interests. Critics may claim depositors cannot be left at any cost as they are the source of credit creation. But the idea of EMI moratorium and suspension of interest payments on depositors could have possibly been a better solution as the waiver is pointless.


Definitions:

Ex Gratia: In Latin, ex gratia means ‘in favour’. It simply refers to the payment made to an individual by government, an organization, or an insurer for the damages caused (claims) but it needn’t necessarily require to admit the liability of the party by making the payment.


References:

  1. Economic Times

  2. Capital Mind

  3. Vivek Kaul's Blog

  4. https://www.capitalmind.in/2020/11/is-there-money-in-your-account-from-the-interest-on-interest-waiver-scheme

- Bharathi Jayaraman (aqf18bharathi@mse.ac.in)