Supreme Court order on compound interest to leave govt poorer by Rs 7,000 crore

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The Supreme Court verdict on Tuesday to adjust or refund the compound interest and waive it  completely for all the borrowers has come as a big boon for individuals and small-medium enterprises reeling under the pandemic. The court has said compound interest for all borrowers availing a moratorium, irrespective of loan amount or category, is to be waived and has ordered that the amounts already recovered as interest on interest for the moratorium period must be adjusted by the banks.

The court noted that the Reserve Bank of India (RBI) and the government have not provided any rationale for the overall borrower’s debt cap of Rs 2 crore for waiver of interest on interest (for six categories of retail/SME loans, according to the government, in tune with the tradition of “handholding small borrowers”), and has directed to provide such relief to borrowers with overall exposure of more than Rs 2 crore as well.

It is likely that Indian Banks’ Association (IBA), RBI or the government may file a writ petition challenging the court directive. They believe that the interest waiver relief should be extended only to small retail/SME borrowers, which are most affected by the pandemic, and not to large borrowers, which have better repayment capacity and are also eligible for other relief measures (including restructuring, among others).

Emkay Global Financial Services said in a report that as per their back-of-the-envelope calculation, allowing waiver of interest on interest for all loans could lead to an interest waiver cost of Rs 6,800-10,600 crore (interest at 8-10%) to the banking sector (including already provided on loans less than Rs2 crore), which would be compensated by the government that is already under a fiscal pressure.

As per estimates by the rating agency Icra, the extended waiver may cost an additional Rs 7,000-7,500 crore to the exchequer. It has estimated the compounded interest for six months of moratorium across all lenders at around Rs 13,500-14,000 crore, higher than Emkay’s estimates.

Analysts believe that the verdict may lead to a “short-term overhang” on the banking sector. The compound interest has been an extra source of income for the banks, which will now be refunded or adjusted over the next couple of quarters.

In its order, the apex court, however, declined other pleas in the case, including a complete waiver of all interest, an extension of the period of loan moratorium beyond August 31, 2020, as well pleas to direct the central bank and the government to provide further relief as well as some specific sector-wise relief.

The government had earlier submitted before the court that if it were to consider waiving interest on all the loans and advances to all categories of borrowers for the six-month moratorium period announced by the RBI, then the amount foregone would be more than Rs 6 lakh crore.

It had said that it would necessarily wipe out a substantial and a major part of the banks’ net worth if they were to bear this burden, rendering most of them unviable and raising a very serious question mark over their very survival.

When the moratorium was announced, many financial advisors had advised borrowers not to avail the moratorium if they can afford to pay, as it would only delay the payment cycle which will only push up the interest payments. While the compound interest would be waived for all borrowers who have availed the moratorium, irrespective of loan amount or category, all other borrowers will continue to pay the interest on interest as usual.

“We believe that this directive of the court is tantamount to an interference in regulatory/government economic policies despite the supreme court accepting that it would not like to advice the govt on economic policies,” Emkay said.

Edelweiss said in a report that the earnings impact of the residual exposure is not very material. “However, this ruling potentially raises questions about judicial reach into the realm of private (bank-customer) contracts. The fact that the government has preempted and absorbed the brunt of this impact should soothe some ruffled feathers though,” said the report.

The court upheld the economic policy decisions as the government’s prerogative. “What is best in the national economy and in what manner and to what extent the financial reliefs/packages be formulated, offered and   implemented   is   ultimately  to  be decided by the government and RBI on the aid and advice of the experts. Such matters do not ordinarily attract the power of judicial review. Merely because some class/sector may not be   agreeable and/or satisfied   with   such packages/policy decisions, the courts, in exercise of the power of judicial   review, do ordinarily interfere with the policy decisions, unless such policy could be faulted on the ground of mala fide, arbitrariness, unfairness, etc,” it said in the order.