Interest-Free Moratorium on Loans; Boon or Bane?

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Context: RBI has also allowed banks to defer payment of Equated Monthly Instalments (EMIs) on home, car, personal loans as well as credit card dues for three months till May 31. The RBI also allowed lending institutions, banks to defer interest on working capital repayments by 3 months — a move aimed at addressing the distress among firms as production is down. Recently, the Supreme court asked the finance ministry for its opinion on an interest-free moratorium.

Relevance:
Prelims: Current events of national and international importance.
Mains: GS III-

  • Indian Economy and issues relating to planning, mobilization of resources, growth, development, and employment. Inclusive growth and issues arising from it.
What is the case about?
  • The RBI has allowed lenders to extend a moratorium on term loans till August 2020-end, following the extension of lockdown.
  • However, the levy of interest during the moratorium period has been challenged.
  • It is said to create hardships to the borrowers and create hindrance and obstruction in ‘right to life’ guaranteed by the Constitution of India.
  • In this light, the Court asked for the government’s opinion on waiver of interest on loans during the ongoing moratorium period.
  • The Court also observed that it could not prioritize economics over health issues.

What is RBI's stance?
  • The RBI has filed an affidavit in this regard.
  • It has argued that a forced waiver of interest would affect banks badly.
  • It would also endanger the interests of depositors.

DEMERITS IN  WAIVING OFF INTEREST

 

How valid is RBI's argument? 
  • Covid-19 and the lockdown have resulted in significant hardships for most economic agents.
  • However, the basic rules of economic and financial governance cannot be discarded.
  • A waiver would result in about a Rs 2-trillion hit for the banking system.
  • Lenders are expecting bad loans to rise because of the pandemic.
  • But, a waiver could affect confidence in the banking system.
  • The government has suspended the Insolvency and Bankruptcy Code for 6 months.
  • This is again likely to increase problems for lenders.
  • The Indian banking system was anyway not in good form even before the Covid-19 crisis.
  • So, in all, it is difficult to find fault with the RBI's argument.
How important are the depositors?
  • If the borrowers are given an interest waiver, the banks' role to service the depositors would be at stake.
  • Banks have an obligation to serve their depositors too and not just borrowers.
  • There is no concrete reason why the system should serve only the interests of the borrowers at the cost of the depositors and investors.
  • Their right to life is no less important than that of the borrowers.
  • Thus, it is important to strike a balance.
What other measures has the RBI taken?
  • To be fair, the RBI on its part has taken several steps to support borrowers.
  • Apart from the moratorium, the central bank has lowered interest rates.
  • This has infused significant amounts of liquidity.
  • Besides, it is widely expected that the RBI would allow a one-time restructuring of debt.
Should interest not be charged on these loans?
  • The Reserve Bank of India (RBI) has estimated that if interest is not charged on loans under a moratorium, around ₹2 trillion will be lost across banks.
  • Deposits that a bank borrows at a certain rate of interest are lent at a higher rate of interest.
  • Only when interest on loans is paid can interest on deposits be paid. Thus, not charging interest on loans under moratorium is a bad idea as it breaks down the functionality of the banks.
Other Repercussions
  • Around half of the households, finance savings are held in the form of deposits.
  • Any move to not charge interest on loans under moratorium can only be financed if no or lower interest is paid on deposits or if the government offers compensation to banks.
  • If no interest is paid on deposits, it can lead to a complete breakdown of trust in the banking system, which must be avoided at all costs.

(MERITS IN  WAIVING OFF INTEREST)

 

Why is Moratorium on loans unattractive?
  • This is because the interest on the loan under moratorium accumulates and needs to be paid by the borrower.
  • The interest on the loan for the moratorium period is added to the loan outstanding at the end of the moratorium.
  • Hence, there have been demands that banks and NBFCs should not charge interest for the moratorium period.
Farm loans are waived, why not interest?
  • When farm loans are waived, the state government needs to compensate the banks.
  • With many borrowers withholding repayment in anticipation of a waiver, the credit history of borrowers and their future prospects of availing fresh loans is affected and it becomes a sort of a moral hazard.
What is the way ahead?
  • A waiver of interest for the entire system cannot be a solution.
  • Besides banks, several non-banking financial companies (NBFCs) may not be able to handle this shock.
  • Failure of NBFCs will increase financial-stability risks.
  • However, the government may believe that certain sections of the borrowers need to be given more relief.
  • In that case, the support should come from the Budget, not the banking system.
  • The health of the financial system cannot be ignored, as the government needs a stable financial system and a functioning economy to fulfill its obligations.



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