Interest on Interest

By Harjas Singh Jaggi

On the night of 24th March, 2020 when our Hon. Prime Minister Narendra Modi announced a 21-day nationwide lockdown to curb Covid-19; all that people cared for was the safety of their loved ones and to get enough food supplies to last those 21 days. But then on 14th of April, 2020 the lockdown was extended till 3rd May which was then again extended till 17th May and then again till 31st May, 2020.

During this nationwide lockdown the Government announced multiple schemes to benefit the common man, out of which one particular scheme that was thought to have given a major relief to the suffering economy was the “Loan Moratorium Scheme”.

As all of the businesses were shut and people could not pay their loan installments, the Ministry of Finance, led by Nirmala Sitaraman asked the banks to offer a “moratorium”, i.e. a time during the loan term when the borrower is not required to make any repayment, for 3 months which was till 31st May, 2020. This moratorium period was extended again for more 3 months. The Ministry also extended the time period to announce a loan as an NPA from 3 months to 6 months.

This decision was appreciated by the majority of the borrowers and 1/3rd of borrowers opted for this scheme. Problems arose, when during the unlock process banks started communicating the benefits of timely repayment which highlighted the biggest flaw of this whole Moratorium Scheme and that was “Interest-On-Interest” which was a nightmare to the borrowers.

What is Interest-on-Interest?

 

Interest on Interest or Compound Interest in this moratorium scheme is the additional interest that will be charged to the borrowers on the amount of “principal + interest” they haven’t paid during the moratorium period.

In simple terms if you’ve taken a loan of Rs. 10,00,000/- (Rs. Ten Lakhs) and you are supposed to pay Rs. 1,10,000 on monthly basis as EMI. Now, if you had taken the moratorium scheme, you’ll be charged interest not only on the principle amount of Rs. 10,00,000/- that you had taken as loan but you will also be charged interest on the EMI of Rs. 1,10,000 per month that you’ve failed pay multiplied by the number of months for which you had taken the moratorium.

Normally, if you see this is simple maths and usually every bank has this clearly mentioned in their Terms and Conditions while giving out loans to its borrowers. But, this compounding of interest especially during such times was not acceptable to a whole lot of Indians as this added to almost 16 more EMIs than they would normally pay. Thus, they took their petition to the Supreme Court. In normal conditions this kind of petition would not be entertained by any court; but to much surprise the court sympathized with the petitioners and asked the Centre to find a solution or common ground to this problem.

The Problems & the potential of relief

 

This is when nightmares for the bankers started, because any waiver in the compound interest given to the borrowers would not only impact the income of the banks but also that of the depositors. This was due to the fact that the interest paid by the borrower to the bank is what forms the ground for the interest paid to the depositors by the bank. RBI and Banks had both tried to communicate this to the Supreme Court with the Centre supporting its stance but it was to no avail and instead the Court asked Centre to come up with its own view point.

Following the order of the court, the Finance Ministry had formed a three-member committee led by former comptroller and auditor general Rajiv Mehrishi on 10th September 2020. Given the fact that the Centre itself was against waiver of any interest, this committee was supposed to highlight the fact that any waiver/further relaxation could not be given to borrowers and how it would have a negative impact on the balance sheets of the banks as they’re also suffering from pandemic.

Here again, the burden of any kind of waiver granted by the Supreme Court would have to be taken by the Government by providing direct, indirect or a combination of both direct and indirect benefit to the banking sector.

In the meantime, the Center had asked the banks to help the borrowers by providing them additional short-term loans with repayment starting after 1 year from disbursement of loan to revive and pay back the existing term loans.

On 2nd October 2020, in a turn of events the Government issued an affidavit stating that it would instruct the banks to waive the interest-on-interest of small borrowers up to the the range of Rs. 2 crores of the following categories – MSME Loans, Educational Loans, Housing Loans, Consumer Durable Loans, Credit Card Dues, Auto Loans, Personal Loans to Professionals and Consumption Loans. This will be beneficial to both the borrowers who had taken moratorium and even the ones who had continued to pay their dues even during the lockdown. This decision was the result of the recommendations of the Mehrishi Committee as these small loans form almost 40% of all loans given out by banks and if NBFCs are to be added they make more than 50% of all loans given out. As mentioned above the burden of this loss to the banks will be borne by the Central Government itself. The Government also said that the official order will be issued and implemented on or before 15th November, 2020.

 

On 14th October, 2020 during the hearing of the case, the Supreme Court welcomed this decision of the Government but also questioned as to the time required for implementation of the order as the government just has to order banks to pass on the benefits to its borrowers. Government successfully justified it stating that every category of loan has a different and a complex method of calculation of EMI and thus it’s a time-consuming process. Also, the people who had not taken the moratorium will have to be refunded by the banks. This calculation is important because the government will eventually have to compensate the banks based on these calculations. It also stated that 15th November is the last date on or before which the order will be issued without any delay. The court accepted this but also scheduled a hearing on 2nd November, 2020 to get an update of preparedness and implementation of this plan by the Government. We hope that the order is given out as soon as possible and small borrowers are relieved from this burden of interest-on-interest.

The fate of big borrowers like that of Real Estate Sector is still unknown as they are also fighting in the same court for a relief on interest-on-interest or demanding at least a one-time loan restructuring of their loans but the court has not taken any decision as of now nor the government has responded to their queries yet.

Till the time the Supreme Court gives its final decision on the Big Sector, the Banking Sector and Government both will be having nightmares because the total compounded interest from moratorium is estimated to be Rs. 15,000 cr. (Rupees Fifteen Thousand Crores) which is a huge amount to bear even by the Central Government who’s already struggling to even pay the GST dues of many states.