The business model of banks looks very simple – It is a safe place for the junta to keep their money with them and earn interest on that investment. Barring a small amount which the bank needs to retain, they use that deposited money to lend to borrowers and charge them a higher rate of interest. The difference, or margin is kept by the banks. It is that simple! Is it? Let’s check!
Bankers have been found to get greedy and have ended up lending recklessly only to have their entire net worth getting eroded with only one of the lenders failing to repay its debt.
However, this time, the banks are not really the ones at fault. For the first 3 months of this financial year, there was barely any economic activity and with negligible cash flows, there was a severe liquidity crunch. This made it almost impossible for a large chunk of borrowers to meet their Equated Monthly Installments (‘EMIs’). To provide some relief to the borrowers and not to get classified as bad loans, aka Non-Performing Assets (‘NPAs’), the Reserve Bank of India (RBI) came up with a never-been-done-before strategy – Loan Moratorium.
Now, you must be wondering what exactly is a Loan Moratorium? It basically means that borrowers who were not able to meet their EMIs during the said period could simply choose to opt for the moratorium thereby postpone their payments to a later date.
Initially, the loan moratorium was announced for 3 months i.e., from March to May 2020, which was later extended by another 3 months until August 2020. However, it was proposed that borrowers who opted for the moratorium had to cough up a bit more than the required obligations when they repay later.
You must have guessed it already!! RBI mentioned that there would be interest charged on the amount that is not paid, basically – interest on interest, i.e., Compound Interest, which is usually acceptable under normal circumstances, but a bizarre idea in the current uncertain circumstances.
This ultimately led to a legal battle between borrowers and the government with borrowers seeking
However, the government formulated a scheme in October which said that it would waive compound interest on loans up to Rs. 2 crores in some categories and would compensate the banks for such interest waiver. The banks would have to credit the difference between the compound interest and simple interest for the moratorium period to the eligible borrowers who had already made the payments. The scheme was applicable also to those who had not made their payments.
Out of the total INR 100 lakh crores debt outstanding, approximately 40-45% were eligible for the waiver of compound interest. The scheme would have cost the exchequer about INR 6,500 crores.
However, the regular interest charged could not be waived of as the government in its affidavit to the Supreme court said that if they were to do so, it would cost them INR 6 lakh crores for a period of 6 months!! This is obviously a staggering amount and the banks were not financially strong to bear this burden and would practically wipe out a substantial portion of their net worth.
In my humble opinion (‘IMHO’), had the government in its AtmaNirbhar Package paid more attention to the existing debt conditions of the economy rather than introducing reforms, using twisted lingos which the common man did not understand and provided the economy with liquidity, there would not have been any dispute and things would have been a lot better.
After all, how on earth is one supposed to pay even a small amount of interest if his business is completely shut or if he gets unemployed because of the pandemic?
However, the announcement of the compound interest waiver by the Government was a well-timed move. Had it been declared earlier; even the capable borrowers would have taken undue advantage of the same (After all, money has got time value) and refrained from paying their interest obligations.
Going forward, it would be interesting to see whether the Supreme Court agrees to the pleas of the borrowers. Well, for that, the case needs to come to an end, and that does not seem anytime soon, just like most of the cases.
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Thank you Yuva members for organising such a fun and informative lecture. We enjoyed it a lot. Meeting and learning from Mihir Sir was really an amazing experience. And this is not only our feeling but all the students enjoyed his lecture very much and look forward to many such events.