When the RBI sought to provide a respite to borrowers by allowing lenders to offer a six-month moratorium on loan repayment, little did it expect that its move would boomerang and land it in a pickle, and even threaten the very financial stability of the banking system.

But as it stands the matter, which began with a plea seeking interest waiver on loan moratorium in March, has not only dragged on (remarkably) for the past six months, but now puts banks (already roiled by the bad loan menace and a flurry of scams), depositors (whose faith in banks hangs by the merest thread) and the regulator (struggling to restore the banking system) in a perilous situation.

All eyes are now on the Supreme Court’s final decision. Should banks grant moratorium with interest waiver?

Or, at least waive interest on interest on the deferred EMIs during the moratorium period? Either outcome can have a severe impact on the banking sector.

Moratorium is not a waiver!

The arguments put forth for the interest waiver are explicable. The moratorium measure was intended to offer respite to borrowers. Yet, banks continuing to charge interest on such loans during the moratorium period, has increased the financial burden of borrowers — substantially higher interest over the tenure (now extended) of the loan. But isn’t that how all moratoriums operate? Moratorium, by definition, is the temporary postponement of payment of interest/principal/instalments, and not a waiver of loan repayments.

Remember, even under the Centre’s credit guarantee scheme, while there is a one-year moratorium on the principal, interest is payable during this period. Even in the case of the US Fed’s Main Street Lending Programme to support small-and-medium sized businesses, while no principal is paid in the first or second year, the deferred interest is capitalised and added to the principal amount. In effect, there is no escaping interest payment under a moratorium!

Waiver can hit banks

Even if one were to argue that the pandemic has brought on extraordinary stress on individuals and companies, how is it the banks’ remit to bear the burden on interest waiver? And, how does one ensure that depositors’ interests are safeguarded while banks forego a major portion of their income?

Banks are in the business of lending and they rely heavily on large deposits. They repay deposits largely from the money returned by borrowers. With bad loans in many banks at over 14 per cent (up to a fourth in a few), if the interest on loans under moratorium were to be waived, it could gravely hurt depositors.

At the overall system level, while the proportion of the moratorium book declined significantly from 25-30 per cent initially to about 10-20 per cent (according to banks’ June quarter results), the book is still sizeable. Total advances as of August stood at about ₹102-lakh crore.

At an average rate of 20 per cent, loans under moratorium would be about ₹20-lakh crore. At 10 per cent lending rate, the interest for six months on the moratorium book would add up to ₹1.04-lakh crore. This is about one-fourth of banks’ net interest income (all listed banks in FY20), and one-tenth of banks’ net worth. A tidy sum to just forego! In fact, for some banks, given the higher proportion of loans under moratorium and higher yields on loans (12-14 per cent), the interest for six months works out to 40-50 per cent of the profit before tax (based on FY20 numbers).

Now, let us look at deposits. To fund the ₹102-lakh crore loans, banks would ideally have about ₹120-lakh crore of deposits (CRR at 3 per cent and SLR at 18 per cent). Let us assume that banks pay an average of 6 per cent interest on deposits — about ₹7 lakh crore of interest outgo. If we assume 11-12 per cent NPA levels (that shrinks banks’ interest income) and entire waiver of interest on moratorium book, then banks’ interest income (on advances) would just about cover interest on deposits.

If a large portion of the moratorium book goes bad, then banks’ ability to pay depositors would debilitate further.

As it is, banks have been recognising interest income on loans under moratorium on accrual basis for the past six months, even as the interest on deposits has amounted to actual cash outflow.

Hence, there may already be an issue of cash flow mismatch for certain banks.

Interest on interest

What about letting go of just the interest on the interest accrued? This has been the other issue raised by the Supreme Court. If we look at system-level numbers, then waiving interest on interest may not appear too much of a blow to banks. It could probably have an impact of about ₹3,000-4,000 crore at best to banks’ interest income.

But that would be too simplistic an argument. For starters, waiving interest on interest goes against the basic tenets of finance. A loan EMI comprises principal repayment and an interest component. Hence, EMI deferment should ideally result in the unpaid interest being added to the principal amount, and borrowers having to pay interest on this increased amount. This is the basis of the compounding principle. Would depositors be willing to let go of the accumulated interest (compound interest) during the moratorium period?

Also, while the overall system level impact may seem less onerous, for certain banks the burden could be more. This is because in a large ticket long tenure loan, for instance a home loan, the percentage of principal repaid in the initial years is relatively low and the interest burden is much higher. Hence, in such cases, wavier of interest on interest would pinch banks quite a bit. Then, of course, any waiver full or partial at this point in time would be morally wrong, for the simple reason that there are borrowers who have continued to pay their EMIs despite hardships. An across-the-board waiver would ruin the credit behaviour (just as in the case of agri loans).

Over to restructuring

Rather than undermine the commercial decisions of banks and force them to forego interest income — as such, interest on advances has declined for many banks in the past two years — it would be prudent to let banks use the RBI’s one-time restructuring tool to aid harrowed borrowers.

Here again, banks should be allowed to formulate their own internal criteria and policies. Rise in delinquencies, muted credit growth and increase in provisions are a given, which have already put banks’ earnings and capital at risk. If banks have to normalise quickly and aid the recovery in the economy through increased lending, they have to be commercially viable. Let us not rock an already rickety boat.

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