In normal circumstances, when an individual or a business takes a loan from a bank, they would have to repay the loan amount with interest. More importantly, there would be a specific time period by which they have to make the required payments. What happens to these entities when they fail to repay the banks or other financial institutions? Their credit scores go down, thus, making it difficult for such entities to get essential loans in the future. Or, the property which was used as collateral for the loan would be taken over by the bank and sold off. These are important facts that we already know.

So let us look at the problems faced by different entities in these challenging times of Covid-19. Then we will jump into what this interest waiver means, and how it will affect different parties including consumers like us by understanding what every guideline means.

Problems faced by Businesses:

We need to establish the fact that there is nothing ‘normal’ about this year. The Covid-19 pandemic has definitely caused a huge impact on individuals and businesses all around the world. Small or large businesses would have taken loans to improve production. In order to scale up, the loan amount could have also been used to increase investments in infrastructure. With the lockdown being imposed in late March in India, most businesses had very few customers. Supply chain (network between a firm and its suppliers) disruptions due to the closing of borders had made it very difficult for many businesses to keep their shops open. 

Problems faced by Banks:

An important factor that we must consider is the view of the commercial banks in our country. One of the main sources of income for banks is the interest they receive on loans. In such cases when customers are not in a position to repay the loan interest amount, financial institutions would have a very tough time conducting its normal activities. It could affect the financial result or position of the banks. (There could be exceptions to this. For eg, HDFC Bank reported a high-profit growth of 18% YoY for Q2). Banks and financial institutions are the backbones of any modern economy. To make sure that they do not fail, there should also be a system in place so that all stressed loans do not get classified as bad loans when borrowers fail to repay.

With almost all economic activities being hit, the Government of India had to step in and provide maximum support to its citizens, while maintaining the welfare of banks. The Reserve Bank of India (RBI) had announced a moratorium on repayment of loans (debt) for three months, beginning from March 1, 2020. What this meant was that businesses and individuals would not have to make payments on their loans during this period. The moratorium period was further extended from May 31st for another 3 months. This was mainly because the number of coronavirus cases in India kept on increasing rapidly, and lockdown rules became more strict. 

The Compound Interest Waiver

Even though the RBI had offered a moratorium, the banks continued to build up the compound interest on these loans over the six month period. Interest-on-interest(or compound interest) is the interest on a loan, calculated based on both the initial amount and the piled-up interest from previous periods. On October 3rd, the Government announced that interest-on-interest for loans up to Rs 2 crores during the six-month moratorium period, would be waived off. This would provide relief to many micro, small, and medium enterprises, and individuals. However, do bear in mind that the banks which had provided loans to these enterprises would be largely affected. It had been estimated that the cost of the compound interest waiver could be around Rs 5,000 – 6,000 crores. This loss would be compensated by the Government. 

On 15th October, the Supreme Court asked the Government to speed up the process for implementing the waiver of interest-on-interest. The Court instructed the Centre to implement the waiver by 2nd November. This is to make sure that individuals or businesses would not suffer more financial losses. 

Guidelines for Implementing The Waiver

On 23rd October, the Indian Government issued the important operational guidelines to banks. The guidelines specified how the implementation of the compound interest waiver would go about. Let us look at some of the important aspects of the guidelines:

  1. The interest waiver scheme would be applicable to loans below Rs 2 crores
  1. The amount of relief should be calculated as the difference between simple interest and compound interest. What this means is that compound interest on loans would be covered or paid by the government. The simple interest amount has to be paid by the borrowers themselves. The relief amount will be credited to the customer’s account.
  1. The relief payment would be calculated on loan repayments in the period between March 1, 2020, to August 31, 2020.
  1. The rate of interest while calculating the relief amount would be the same as the rate in the loan agreement. This is to ensure that there is no confusion, in case the interest rate has been increased or decreased by banks during the moratorium period.
  1. The government has identified eight categories of loans under this scheme. The categories include micro, small, and medium enterprises (MSME) loans, educational loans, housing loans, consumer durable loans, credit card dues, auto loans, personal loans to professionals, and consumption loans. People who have taken loans based on any of these 8 categories would be eligible for getting relief. Check with your bank to see if you can avail the scheme.
  1. In the case of credit card dues, the rate of interest will be the weighted average lending rate that is charged by the card company. The scheme will also be applicable only for transactions financed on an EMI basis between March and August. The weighted average is a method of calculating the average, in which some elements carry more importance than others.
  1. In the case of loans that were given as cash, normal interest will be calculated on a daily basis at the rate as of February 29, 2020. The compound interest will be calculated on a monthly basis. The amount that comes as the difference between both these rates will be credited to the customer’s account.
  1. The compound interest waiver applies to all lending institutions such as banks, non-bank finance companies (NBFCs), and housing finance companies.
  1. The scheme can also apply to those who had not utilized the RBI moratorium plan, and had continued with the repayment of loans.

The entire cost of the compound interest waiver would be borne by the government. It has been estimated that the scheme would cost Rs 6,500 crores. The banks (or lenders) have to submit all claims for reimbursement by 15th December 2020. The State Bank of India (SBI) will provide the necessary support to the government for receiving and settling all claims.

Conclusion

During these tough times, it is of very high importance that individuals and businesses get support or relief. The effects of non-repayment of loans can have a huge impact on their future activities. On the other hand, it is also essential that compensation is provided for lenders such as banks and other financial institutions. The new scheme would certainly help to balance the present economic conditions in India.  Let us hope that these guidelines will be implemented accurately, and every entity gets what they deserve. 

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