The interest conundrum during moratorium period

The Supreme Court has referred the matter regarding levy of interest during moratorium period back to the Government. The apex court observed that there is no merit in levying interest on interest during the moratorium period.

As reported in the media, one of the judges suggested that the Government could either consider bearing this burden of waiving interest on interest on borrowers or equip banks to do this. The observation was made while hearing a petition filed by an aggrieved borrower, seeking legal intervention. The next hearing is scheduled in August.

Background

In view of the Covid crisis and consequent lockdown, the RBI had extended an option to all borrowers of banks, FIs and NBFCs, to avail themselves of a six-month moratorium, up to August 31, on their debt-servicing obligation. The entire relationship between the borrower and lender, as provided for in the loan agreement is to survive, except for the moratorium. The moratorium is expected to ease interim liquidity, at a time when operations of units, and income of retail individuals, are adversely affected.

The moratorium has been timely and generally welcomed. However, two petitions have been filed seeking (a) similar moratorium in debenture servicing also; and (b) non-imposition of interest during the moratorium period.

The first petition appears to have been filed on the notion that moratorium, if extended, is to be uniformly applied for all fund-raising programmes, and there cannot be a difference in rules between servicing obligations for a debenture and a bank loan, particularly in the present extraordinary situation.

The first petition affects debenture-holders, including small investors investing through mutual funds. After hearing the petition, a single judge Bench of the Delhi High Court held that no coercive action could be taken against Indiabulls Housing (petitioner) for failing to pay dues of debentures. Aggrieved by the order, AMFI, Debenture Trustees, and SEBI (market regulator for debentures), moved the Delhi High Court

It was argued that the RBI circular, which was a relief meant for term loans, cannot be equated with debentures. The Division Bench of the Delhi HC stayed the interim protection allowed by the single judge. Indiabulls is now required to pay debenture-holders as per due date.

The second petition adversely affects banks and is being contested by them. Banks fear loss of income, in case the petition is upheld, and feels that borrowers should continue to pay interest, including interest on interest, during the moratorium period. The RBI has made its submissions in the Supreme Court in favour of banks. The following paragraphs analyses why an apparently different approach regarding payment of interest during moratorium as held by the two courts is justified.

Debentures

Debentures are financial instruments, through which an issuer raises money. The terms and conditions of debentures, including date of servicing of debenture dues, are spelt out in the Offering Circular (OC) which is issued, prior to raising money. Any subscription/receipt of money in the issue, is on the basis of the terms and conditions of the OC, which is accepted by issuer and investor.

A debenture issue is a direct transaction between the issuer and subscriber. Any amendment to the terms and conditions, spelt out in the OC, can be made only after obtaining an approval from the debenture-holders through their debenture trustees. It may not be possible nor desirable for the regulator, the government or the courts to impose an order to amend the terms of an issued debenture series as, ipso facto , sought by the petitioner.

Bank loans

Banks have opposed the aforesaid petition (b), mainly on the ground that non levy of interest on their loans would lead to a decline in their income and cause difficulty in their ability to service deposits. There is no doubt that non levy of interest, as prayed in the petition, would adversely affect income of banks.

Further, considering the low reserves/capital base and weak financial position of banks today, such reduction in income could cause stress in the banks. Servicing of deposits, if serviced only out of current income by banks, may then be difficult.

It is important to note here that the moratorium policy was adopted in the backdrop of an extraordinary situation, exogenous to the borrower, and beyond his/her ability to correct. The moratorium recognises the temporary inability of the borrower (both retail and corporate) to pay/repay in a situation of complete stoppage on account of an order by the state.

In case the borrower is unable to recoup the loss incurred during the lockdown period, there is a clear justification for seeking relief in non levy of compound interest, during moratorium. However, as depositor-bank relationship is a different contract and is independent of the borrower-lender relationship, it may be difficult to oppose the petition on the basis of inability to service deposit liability.

The writer is former Deputy Managing Director of EXIM Bank and former MD & CEO of IDBI Asset Management Company