The six-month moratorium announced by the Reserve Bank of India to help borrowers who suffered due to the Covid-induced lockdown came to an end on 31 August. Many lenders had called upon the RBI not to extend the moratorium, arguing that it would lead to a spurt in NPAs while unduly benefitting borrowers who could repay loans.
After the moratorium ended, a number of individual borrowers, hotel associations and real estate companies filed a petition before the Supreme Court, seeking an extension of the moratorium and waiver on interest payments charged by banks on instalments deferred during the moratorium period.
The Supreme Court provided immediate relief to borrowers by extending the moratorium till 28 September. It also sought the government’s views on the issue of waiver of interest on interest on loans, and the government said it had agreed to bear the cost of the interest on interest for MSME loans and personal loans up to Rs 2 crore.
The court is now nudging the government to implement the decision to waive interest on interest without delay, and come back with an action plan by 2 November, while the government has assured that the decision will be implemented by 15 November.
Burden on banks
If the government had not intervened, waiving of interest on loans would have caused a financial burden on banks. Addressing the banking sector’s issues has to be a part of the strategy to revitalise the economy.
The interests of borrowers and banks alike have to be balanced. Banks are paying interest on deposits and need interest income on loans to sustain their business. Thus, while borrowers impacted by the Covid-19 lockdown need a cushion, if banks are directed to waive interest accrued on loans, the government should step in to reimburse the cost incurred by banks because the lockdown was done to control the negative externality, i.e. the spread of Covid.
The government has offered a fair solution to bear the interest cost on loans of up to Rs 2 crore to prevent an adverse impact on banks’ balance-sheets. It is bearing the cost of an action done with the objective of improving public health.
How restructuring can help
While the SC directed the moratorium to be extended by another month, the RBI announced a one-time restructuring of loans to provide relief to retail, MSME and corporate borrowers. The one-time restructuring will help soften the Covid-19’s impact on borrowers.
The debate now seeks to balance the interest of banks, small savers and depositors with that of borrowers as the SC hears the case on moratorium on loan repayments. RBI has prayed before the SC to lift the stay on classification of loan accounts as NPAs. Non-recognition of NPAs would result in a huge pile up of bad loans. A recent estimate suggests that banks’ gross NPA ratio is likely to be 11-11.5 per cent by the end of this year. Rising bad assets would constrain banks’ ability to meet regulatory norms on capital.
The after-effect of an extended moratorium on banks’ balance-sheets is likely to play out for much longer. Economic recovery is expected to be slow and patchy, and muted credit growth implies that banks’ interest income is expected to be limited. At the same time if deposits grow at roughly double the rate of growth of credit, they could pose a strain on banks’ balance-sheets.
While the government plans to infuse Rs 20,000 crore through recapitalisation, given its fragile fiscal situation, banks cannot depend on the government to infuse large sums of money through recapitalisation. The regulatory prescription with regards to the recognition of bad loans needs to be restored.
If banks are allowed to slip into the ‘extend and pretend’ mode — whereby loans are not recognised as bad assets and companies are not taken to bankruptcy courts by creditors — this could create moral hazard issues, and result in a repeat of the mistakes of the previous years. Borrowers who have the capacity to repay loans may not feel the pressure to do so.
In the absence of a dedicated resolution mechanism for banks, a handful of banks could then be asked to rescue troubled banks.
As the economy opens up and some of the high frequency indicators show signs of an uptick, we can hope that the worst economic contraction is behind us. As economic activity picks up, borrowers should be able to honour their payment obligations to banks. As such, a more credible measure of relief to borrowers lies in a case-to-case loan restructuring mechanism.
Banks act as intermediaries between depositors and borrowers. A one-sided relief measure focussed on borrowers has the potential to disrupt the banks’ core function of intermediating funds between borrowers and depositors. This could deter depositors from depositing money in banks, and consequently, hamper the next round of credit growth. Small businesses who depend on the banking system for their credit needs would suffer.
Ila Patnaik is an economist and a professor at National Institute of Public Finance and Policy.
Radhika Pandey is a consultant at NIPFP.
Views are personal.