Waiving Compound Interest: Finding The Good In A Bad Idea
It is now near certain, that we will see a new class of waivers introduced into the Indian banking lexicon. The compound interest or ‘interest-on-interest’ waiver.
On Monday morning, the Supreme Court continued with hearings in the matter, after the Government of India filed an affidavit on Friday. In this affidavit, the government took a position that it is willing to waive compound interest for all borrowers with loan amounts less than Rs 2 crore. This would be applicable for MSME loans and retail loans across most categories. The affidavit also suggested that this relief would be applicable to all borrowers “irrespective of whether the borrower had availed of the moratorium or not.”
The proposal, subject to a final view taken by the Supreme Court, has generated much debate.
Do Nothing - The Rejected Option
Let’s first say that the ideal option would have been to reject calls for any waiver of compound interest.
The Reserve Bank of India, after offering a six-month payment moratorium, has also permitted a one-time restructuring of retail and corporate loans. Restructuring of MSME loans was already permitted under a previous scheme. This restructuring permits an extension of loan tenures by up to two years, giving a longer pay back period for any borrowers in distress. This is possible without the loan being tagged as non-performing, although at a cost.
As such, the regulator in-charge has already done a fair bit to help stressed borrowers. Some would say that it has done more than it should have. If at all additional steps were needed, the ideal authority to decide on those steps should have been the RBI.
Yet, the Supreme Court persisted with hearings on the matter rather than leaving the decision to a the competent regulator at an early stage.
For some reason, the government then set up a committee to examine the matter. It must be noted with concern that there was no representative of the RBI on this committee, which comprised of a former banker (S Sriram), a former bureaucrat (Rajiv Mehrishi) and an economist (Ravindra Dholakia).
The committee’s full report is not public so it is unknown whether the government’s proposal is fully or partially based on the committee’s recommendation. Either way, it seems like the government has rejected the ‘do nothing’ option and offered a palliative of sorts.
Minimise The Harm
Having decided to do something, perhaps the idea should be to minimise the harm. Does the proposed solution keep to that principle?
Here’s one way of looking at it.
The government said that it will waive compound interest for all borrowers. If the government had decided to do this at the time the moratorium was announced, it would have been an across the board subsidy. With no cost attached to deferring repayment installments, the number of borrowers availing the moratorium would have likely gone up.
But the government didn’t do this. So now we have different categories of borrowers — those who took moratorium for all six months; those who took it for a part of the six months; and those who didn't take it at all.
Now you want to compensate these borrowers. How do you do it?
If you only compensate those who took the moratorium, you are sending the wrong signal — weak credit gets rewarded. A more equitable way, at least from the perspective of the relief giver, is to give the same amount of relief to all borrowers.
But what about the relief seeker?
Those who took the moratorium and have compound interest accrued, will see that waived. Those who took the moratorium partially, will see a smaller compound interest waived and rest set-off against a future payment. Those who did not take the moratorium at all, will see the amount fully set-off against a future payment.
Beyond the decision, the implementation will not be easy and questions will arise along the way.
First, the government seems to have opted for a uniform Rs 2 crore threshold. That is reasonable for MSME loans but very high for retail loans. Should the government set at least two separate limits for those broad categories? They probably should because as things stand now, the applicability of this scheme will be wide.
“Our estimate suggests that this would cover 45% of total bank loans and most retail NBFC loans. A simple back-of-the envelope calculation suggests that the cost of the scheme could be at Rs 5,000 crore for banks and Rs 3,000 crore for NBFCs,” said Kotak Institutional Equities in a note dated Oct. 5.
A technology solution will also be needed. If indeed the intention is to offer the benefit to all borrowers, notional amounts will have to calculated for a large number of clients. IT systems will then presumably have to be reset to find a way to compensate these borrowers by setting off the government relief against a future payment. Similarly, if some borrowers have paid the compound interest after the moratorium ended, they would have to be compensated.
Finally, as Kotak Institutional Equities asked, over what period of time will the government compensate lenders?
We would want some more clarity on the reimbursement period for this scheme. In the past, we have seen through the agriculture loan waiver that this period of reimbursement could be a lot longer. Also, the government could inspect the books of the lenders to ensure that the calculations are correct and the loan waiver has achieved its intent. In the past we have noticed that there are usually some differences on these issues.Kotak Institutional Equities Report
A cumbersome exercise awaits.
The easier and the right thing to do was nothing. Both for the government and the apex court.