Interest on Interest Waiver: Is the move justified?

Loan - a word, which in itself has both positive and negative impacts on a person. On the one hand, it is a monetary blessing which gets an individual, company or entity one step closer to achieving whatever it is they desire; and on the other hand, it is a stressful liability, which comes in the form of expensive EMIs and regular interests, failing to pay which, tends to trap the borrower in an almost inescapable trap of hefty penalty and interests.

In the recent times of the disastrous COVID-19 pandemic which disrupted several national economies, India was also amongst the ones which were severely hit. The "most vulnerable section", the middle class, retail borrowers, and small businesses suffered the worst hit as the pandemic-induced lockdown brought upon a sudden halt to business activities.

Because of this, the government had ordered banks to provide a 6-month moratorium on loan EMIs, thus increasing the pay-up period and providing brief relief to the borrowers. However, the EMIs and interest during this moratorium were postponed and not waived off, and thus compound interest was also charged on the accumulated amount of the EMIs.

Owing to all of this, several requests were made to the government and banks to waive off the EMIs or the interest on the loans, which is why the Indian government announced a decision with the objective of reducing this financial suffering.

The government, in its affidavit submitted to the Supreme Court, said that it supports the waiver of compound interest (interest on interest waiver) for loans under a moratorium for certain categories, which might prove to be a blessing for small borrowers.

What Does the Proposed Affidavit Say?

The Indian government has proposed to subsidize interest costs for small borrowers who had availed of a six-month loan repayment moratorium to survive, as the pandemic hampered cash flows.

The charges on loans up to ₹2 crores during the six-month moratorium period through August, will be waived off, according to an affidavit filed by the Ministry of Finance in the Supreme Court on Friday. The affidavit describes the small debtors as a "susceptible class and has determined to proceed to handhold the small debtors."

In its affidavit, the government informed the apex court that this benefit would be extended for loans taken up by micro, small and medium enterprises (MSMEs), housing loans, consumer durables, education loans, auto loans, personal and professional loans, credit card dues, and consumption loans.

Any individual/entity whose loan amount exceeds Rs 2 crore, will not be eligible for the interest on interest waiver and the benefit shall be confined to only the above-mentioned categories of borrowers.

The affidavit also says that the government's plan to bear the burden of the interest on interest waiver will also include borrowers who did not avail of the moratorium. The finance ministry has also said that it will explore options such as cash backs for MSMEs and individuals who have debt up to Rs 2 crore and the ones who repaid their dues on time.

This will ensure a level-playing field with those who availed the moratorium and can now be exempted from being charged "interest on interest".

The important point to note here is that the proposal seeks an interest on interest waiver (Compound Interest) during the moratorium period, but the simple interest on the said period will be borne by the borrower.

This move may cost the exchequer about 5000-7000 cr, mainly due to the presence of large categories of lenders, including private and public sector banks, non-bank financiers, small finance banks, and others.

Why Can't the Interests be Waived Off Altogether?

The affidavit submitted by the government stated that "banks will have to let go of 6 trillion rupees if the interest on all loans are waived off, and that will wipe out a substantial part of lenders' net worth and threaten their survival.

The Indian banks are already short of capital, and a total interest waiver would have resulted in further depletion of its resources. Earlier, the Supreme Court also rejected petitions that demanded a complete waiver on loan interests, stating that the banks were also struggling due to the pandemic.

The lockdown has disrupted the banking sector quite heavily, owing to a lack of new accounts, borrowers, and other facilitates, as the citizens' expenditure is bottled down. Thus, an already burdened and threatened industry cannot be overloaded with yet another hefty financial burden.

To tackle the worsening condition of banks, the Parliament, last month, had approved investments worth ₹20,000 crores into public sector banks (PSBs) through government securities as the COVID-19 crisis had put borrowers under pressure, increasing the threat of a rise in non-performing assets.

Is the 2 Crore Loan Cap Justified?

The announcement of the interest on interest waiver has sparked many concerns and debates, especially regarding the total cap of the loan amount. It has been argued that the cap of loan up to Rs 2 crore is almost unjustified for retail and middle-class borrowers, for whom this move was announced in the first place.

If an individual is able to afford a 2 crore loan, it is quite evident that they do not fall in the middle class or retail borrower category. A person who can afford a 2 crore loan will not be "vulnerable."

It has been suggested that keeping the same loan cap for both middle-class retail borrowers and MSMEs is not a comparable scale, and hence, the 2 crore cap can be set for the MSMEs but should be brought down for other categories.

Another argument against the move is that this waiver will be unfair for those borrowers who have been paying their dues duly and regularly, despite the financial crisis. The recent farm loan waiver was a similar example which has shown that such moves often tend to discourage the honest borrowers who pay their dues on time and can make people take the process casually, thus leading to heavy defaults in loan payments. This can thus penalize honest and disciplined borrowers and provide relief to rich borrowers.

The Bottom Line

The final decision of this interest on interest waiver lies with the Supreme Court, which was initially set to hear the case on 5 October, but now the date has been extended to 13 October. The finance ministry will also have to seek the Parliament's approval in the Winter Session for additional funds to support the compound interest waiver.

The impact of the move on the national finances will not be immediately known, but the government has informed the apex court that bearing this burden would "naturally have an impact on several other pressing commitments being faced by the nation, including meeting direct costs associated with pandemic management, addressing basic needs of the common man and mitigating the common man's problems arising out of the loss of livelihood."

Given the current situation of economic distress, with this new move, the government will have to further stretch its finances by borrowing more than what was initially in the budgets. According to a Care Ratings report on 25 September, the total amount borrowed so far this year is ₹7.7 trillion, which was 82% higher than the corresponding period last year.

All in all, this decision comes off as a great relief to India's struggling middle-class section as well as other small borrowers, who had been struggling hard to financially survive in this stressed economy. With the interest on interest waiver, a heavy burden will be lifted off from their already-burdened shoulders.

But is the move actually a relief to them, or will it act as a shield to the rich borrowers? As much as the court and the government need to worry about the banking sector, they also have to ensure that this move creates a level-playing field for all sorts of borrowers (in regards to the 2 crore loan cap), especially for the honest, middle-class tax-payers. It is crucial to ensure that this money drawn from vulnerable sections is not used to subsidize the richer sections.

Looking at the bigger picture, it is clear that the banks are in no condition to handle this waiver on their own, thus resulting in the government to come to the rescue. But, will the government be able to handle this? Will this heroic call of rescue become a burden for the struggling government finances?

We'll leave that to your thinking and to the future.