The Covid-19 Moratorium Solves Only Half Our Problems
On March 27, the Reserve Bank of India announced a ‘Covid-19 regulatory package’ comprising several measures to help the financial sector and borrowers deal with the impact of the global pandemic. A key measure was allowing all lending institutions (banks, NBFCs, etc.) to grant a ‘moratorium’ on installments and interest falling due until May end. RBI, in the exercise of its powers as a banking regulator, explicitly clarified that the deferment of such installments and interest, will not be classified as ‘defaults’, which would have otherwise triggered an asset classification downgrade in the lenders’ books.
The package is timely, welcome and largely in line with what ought to be done to mitigate the economic distress likely to be triggered by a nationwide lockdown of businesses. However, there are two broad areas of concern that need to be addressed to make the package truly effective.
- First, the fine print of the circular raises several questions on the implementation of the relief and the overall cost-benefit analysis of the moratorium.
- Second, the moratorium solves only half the problems of the credit market in India.
There is an urgent need for coordination between the financial sector regulators to ensure that the temporary moratorium on bank borrowing does not disrupt the public debt market which is already reeling from the impact of the IL&FS and DHFL crises.
Automatic Or Optional?
At the outset, the language used in the circular is permissive giving considerable leeway to the lenders to decide whether or not to grant a moratorium on the terms specified in the circular. For example, it states “…all commercial banks …, co-operative banks, all-India Financial Institutions, and NBFCs (including housing finance companies) (“lending institutions”) are permitted to grant a moratorium of three months on payment of all installments…”. Similarly, the circular leaves it to the banks to draw up board approved policies “for providing the above-mentioned reliefs to all eligible borrowers, inter alia, including the objective criteria for considering reliefs under paragraph 4 above..”.
In a competitive credit market, this flexibility might have driven all lending institutions to offer this relief to their borrowers, even in the absence of a regulatory mandate. However, in an uncompetitive banking sector like India, it is unclear how this will play out and to what extent different banks will offer the best possible terms to their borrowers. For example, most public sector banks have offered the benefit of the moratorium equally to all term-loan borrowers, except those who explicitly opt-out of it. This may, on the face of it, seem like a good idea for those who propose to avail of the moratorium. For several borrowers, especially credit card holders, it might not be optimal to avail of the moratorium and accumulate the interest liability for these months. Furthermore, there would be corporate borrowers with loans from multiple banks, which take a different approach to grant a moratorium.
This could lead to a fair degree of confusion and smaller, less-informed borrowers who may need the moratorium the most may not get it.
The language of the circular and subsequent press statements by lenders seem to suggest that the moratorium is not automatic, and will require further action on the borrowers’ part. If the moratorium depends on borrowers having to apply for it, it raises questions on the treatment of borrowers who default during these three months without having explicitly sought the benefit of the moratorium.
While the RBI’s approach of allowing the banks to cater the terms of the moratorium to their own requirements is in the correct direction, it assumes a certain role for banks to communicate enough and clear information to their borrowers to allow them to make an optimal decision for themselves. This requires a clear communication strategy that is both speedy and implementable, which in turn, assumes that banks have this capacity in partial lockdown conditions.
Maintaining A Balance
Second, the moratorium applies to term loans, credit cards, and borrowings through cash credits and overdraft facilities. This accounts for over 96 percent of the outstanding loan portfolio of banks.
The portfolio of an Indian household is heavily concentrated in banks. Bank deposits account for 65-70 percent of the household savings in India. In the last nine months alone, India has seen two bank failures, and depositors’ confidence in banks is likely to be significantly low right now, as partly reflected by a historically low deposit growth rate of around 9.5 percent.
The moratorium must draw a balance between forbearance for distressed borrowers and the lender’s ability to service its liabilities as and when they accrue.
The moratorium applies to products, such as credit cards and EMI-loans, which are accessible to a fraction of the Indian population, who have reasonably-stable income and savings. Currently, most employers in urban large and medium centres are following a work from home policy, and salary payments have not yet been suspended en masse. It is possible that this might happen in the next few months, in which case the intervention can be recalibrated to the appropriate segment of borrowers.
A more nuanced intervention would involve a compulsory moratorium on working capital loans to firms and businesses to enable them to tide over the next few months without announcing immediate pay cuts or layoffs.
For example, a salary account which does not see an interruption in salary payments would not be eligible for the moratorium. Lenders are best placed to have this information about their borrowers and implementing a moratorium linked to the borrower’s financial health would be administratively feasible for them. This would allow for maximum impact without compromising the financial health of the already distressed banking sector.
Impact On Overall Debt Market
Third, a moratorium on the installment payments due to NBFCs and other lenders would, in turn, impact their ability to service their own debts, possibly triggering a wave of defaults on the bonds issued by them. India has a sizeable public debt market, a large segment of which finances banks and NBFCs.
Retail and institutional investors such as mutual funds, banks, and insurance companies, which have exposure to this market, will be indirectly impacted by the moratorium. For example, such bonds may see an investment downgrade by rating agencies. A mutual fund holding such bonds would require to write down the value of these bonds. Some of these mutual funds may choose to side-pocket bonds issued by banks and lending institutions covered by the moratorium, that is, segregate them from the non-defaulting bonds in the scheme, in anticipation of such defaults.
In this context, there is an active role for SEBI. The valuation of bonds in India largely hinges on their investment grade, and on March 30, 2020, SEBI has directed credit rating agencies to carefully distinguish between moratorium-related defaults and other defaults while reviewing the ratings on such bonds. In addition to this, SEBI should mandate banks and NBFCs with listed debt securities to proactively disclose the extent to which their cash-flows will be impeded due to the moratorium. This is critical information for credit rating agencies and public investors to appropriately account for the loss on their own balance sheets.
The cascading effect of the moratorium will affect institutional lenders having exposure to the bonds issued by banks and NBFCs. These institutional lenders are, in turn, regulated by SEBI, IRDAI, and PFRDA, which underscores a need for close regulatory co-ordination now more than ever before.
Harsh Vardhan is Executive-in-Residence at the Center for Financial Studies of the SP Jain Institute of Management Research. Bhargavi Zaveri is a senior researcher at the Finance Research Group.
The views expressed here are those of the authors and do not necessarily represent the views of BloombergQuint or its editorial team.