Who's to take a haircut?

A tale of moratorium and interest waiver...

Sep 27, 2020

“March comes in like a lion, out like a lamb”

— thus said 2019, little did he know that his successor won’t live up to his expectations!

And finally, 2020 arrives and brings with it the darkest phase for the world economy… COVID peeps in, nations lock down, businesses devastated, people laid off, income levels falling and the effect multiplying on and on! Back then, a big concern for central banks was how to keep the economy afloat. Consider India. People’s falling income posed a great threat to their ability to repay debts (loans). And non-payment would have badly affected their credit scores (e.g.- CIBIL scores), thus, limiting their credibility to obtain further loans in the years ahead! Non-payment would have also made the banks forcefully sell-off the mortgaged properties and thus, leading to a bigger havoc! The onus was on our superhero, the RBI, to help us out. And they came up with an escapeway — The Moratorium.

For the uninitiated, Moratorium is a time period for which repayment of loans is ‘delayed’. Simply put, you aren’t liable to pay your EMIs during this period. The RBI announced a moratorium period from 1st March to 31st May, and then extended it to 31st August; i.e. a total of 6-EMI Moratorium Period. Wow, is it? No guys, no.

Because your EMIs are ‘delayed and NOT forgotten’. You will still have to pay them in full, when the 6 months moratorium ends. It’s NOT an interest waiver (‘byaaj maaf nahi hoga’). You will also have to pay the ‘interest on interest’ accrued during the moratorium period, either by extending your tenure or increasing the EMI. For instance, a home loan of Rs. 45 Lakhs taken on 1st January 2020 with 25 years tenure, if opted for the moratorium, will require an additional payment of ~ Rs. 6.30 Lakhs as ‘interest on interest’, an extra 24 months of EMI! OMG… That’s compounding, working against you. And on the face of it, that’s a pure blunder! Where is the relief then? Well, it’s more grief than relief... it’s a clickbait!

You see, there are two parties to this contract, the borrowers (individuals and businesses) and the lenders (banks, NBFCs, etc.). And what is the ‘clash of claims” all about, you ask? Well, see —

Think of borrowers — real estate companies, power utilities, shopping malls, small businesses and especially the informal sector (labourers, hawkers and peddlers, etc.). There hasn’t been any sign of revival, whatsoever. With the GDP growth rate going negative, inflation rising and unemployment at heights, situations have only worsened. Look at the reports and you realise that more than 12 crore shops are either closed or are on the verge of closure! And now, asking them to pay interest and the compounding interest on loans is ‘worse than taking a pound of flesh’, as a senior advocate points it out. Business organisations say that this payment will hit their (already) cash-strapped condition and they will be forced to lay-off more employees! Individuals struggling with their finances, who are barely able to meet their bread and butter, claim that they aren’t in a position to over-burden their debts with these interest payments! Everyone is like – “Why don’t you just waive off (forget) the interest payments? Yes, we know that this is against the basic principle of finance, but can’t we call it an exceptional case due to an act of god?” And now, with the Supreme Court being sympathetic to the borrowers, the banks are in a trouble.

Think of lenders – the banks and NBFCs. The total accumulated and unpaid interest on loans under this 6 months’ moratorium is around Rs. 2 Lakhs Crores with the interest on this interest of about Rs. 5000 crores! And you’re asking to just waive it off, I mean seriously? RBI estimates that loss of this interest on loans would cut the sector’s income by at least $ 27 billion or 1% of India’s GDP. That’s humongous! Well, you may say that the banks should not be looking to make profits during pandemic. But remember that the bank doesn’t create money out of thin air!

Where do these banks get all the money to lend? Well, there are more than 1.9 billion deposit accounts in these banks, quite more than the number of borrowers! Banks channelize the depositors’ money into the hands of borrowers. Thus, giving a relief to the borrowers will (obviously) lead to lower interest for depositors. See… the typical borrower is a well-placed individual who has (probably) met all his basic needs and can afford to pay an EMI for a car or a house. The borrower may even be the owner of a large company who can afford to pay a lawyer all the way up to the Supreme Court. Whereas the typical depositor usually includes poor people, who don’t even know that they are getting a lower rate of interest because the bank has to forego interest from a borrower, and worse... the depositor also may have lost his job due to COVID and might be depending on the interest received on his savings for bread and butter! The depositor may be the aged and the elderly who are living on the interest that their savings are earning. They too are probably hit by unexpected health bills. Is it fair to snatch a bit of their earnings to give relief to a borrower? Why is the pain of the borrower more important than the pain of a COVID-hit depositor? And if you do away with the money that belongs to the depositors, that would be a trigger for another PMC bank scam (although that was deliberate)! Moreover, that would be like punishing the ‘good’ borrowers for paying their loans on time!

So, ‘Who’s to take the haircut?’ (who will bear the loss, hmm?) Well, the easy target of all, you would say the Government, is it? Why not ask the Government to pay the interest portion on behalf of the borrowers, hmm? But where does the Government obtain all the money from? From taxes, right? So, now you are saying, the relief to some borrowers will be provided out of taxpayers’ money. Well, ask yourself, will you give your consent for this, if you aren’t a borrower? Will you just give away your hard-earned money to bail-out borrowers? You may, but most won’t! And that would give rise to another nation unrest! So, the case of Government funding the interest portion is also ruled out!

Now it is clear, howsoever borrowers claim, interest waiver isn’t at all a ‘viable’ option! Fast forward 6 months… the moratorium ends on 31st August and the RBI was in a catch-22 situation! And now you know why. Total loans under moratorium was more than Rs. 38 Lakhs Crores (plus interest of Rs. 2 Lakhs Crores) and most of it would have turned irrecoverable (NPAs) for the banks as the conditions haven’t improved yet! Something had to be done. But there wasn’t any concrete solution as of 31st August. So, the apex court, the SC, gave the government 28 days’ time till 28th September to come up with something. Then what? How to settle this dispute, you ask? Well, we don’t know that. But probably, a one-time Loan (Debt) Restructuring, as permitted by the RBI is probably the only viable option.

Basically, a loan restructuring mechanism implies that the borrower and the lender of money renegotiate the terms of the loan to make it easier for the borrower to repay the money. The changes could be like increasing the tenure of the loan, converting interest portion into another loan, a further moratorium, etc. Based on the recommendations of the Kamath Committee, the SBI & HDFC banks have already announced that they’ll allow restructuring by way of moratorium for some (eligible) loans for a maximum of 24 months; i.e. you aren’t required to pay EMIs for two years. However, this isn’t a ‘free gift’! It obviously comes with some fees, for instance, SBI requires annual payment of 0.35% of additional interest for the tenure of the loan. Ultimately, it will make you pay a lot more than you can save! And the past figures also point south! After a similar loan restructuring exercise during the crisis of 2008, all the restructured loans, ultimately turned bad; i.e. the borrowers weren’t able to repay the money. Many business tycoons availed the same and either turned bankrupt or their loans exist only in papers! Ergo, it would be prudent on the part of banks to exercise maximum due diligence so as to ensure that the benefit does not get to the wrong hands.

While we can debate a lot on this topic, all eyes (and ears) will be on the Supreme Court’s verdict that is to come up tomorrow (28th September). The SC has rejected the plea for the waiver of interest of Rs. 2 Lakhs Crores, which means you will still have to pay this. However, the ‘interest on this interest’ accrued during these 6 months ( ~ Rs. 5000 crores) is under question, and will depend upon tomorrow’s verdict. By the way, how the heck do you ask SC to make commercial decisions that will affect the whole economy! Well, what can we do? Let’s just hope that they pronounce a decision with due consideration to all facts. Let’s hope the decision is fair and equitable for all.

And as CNBC notes —

Short point, charging interest on delayed payment of interest or principal is the bedrock of banking. Any relief in terms of time or amounts should be taken only after looking at principles of equity for both sides - savers and borrowers as also the financial stability of the banking system. The expert, best placed to decide this, is the banking regulator -- Reserve Bank of India. They are in court in the interest of the depositor and in the interest of the financial stability of the economy. They are also the experts on the logic of interest rates. Their lordships [the SC] must please heed their view in the interest of the country.

The Oracle of Omaha, the legendary investor, Mr. Warren Buffet quotes —

“Never ask a barber if you need a haircut”

— simply put, each one will look for his own benefit out of an arrangement. And thus it is wise for all of us to get properly informed and consider all aspects of the problem statement, before outrightly throwing an opinion. Because half knowledge is more dangerous than ignorance!

So, hey guys, hope you loved reading this piece!

Actually, I heard a number of individuals giving an opinion on interest waiver without even knowing the facts. That’s why, I thought of helping all of you make a ‘proper’ sense of what all this debate is about. And when the SC gives its verdict tomorrow, and someone comes up for a debate, you can go there and nail it!

Do you know someone who hasn’t been able to figure out what this is all about? Please share this article with them. I can reasonably assure that this will bring them to the point.

I would be more than happy to hear from you.

Gen Z's Words

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