Money Matters: Your Lordships, please let RBI decide in our interest
The Supreme Court is currently hearing an all-important case on loan moratorium, where the petitioner, who availed a moratorium on his home loan, is arguing that he should not be charged interest on the delayed interest installments. The case has become famous as the "interest on interest" case. This note argues that charging interest on someone who delays interest payment is normal banking and deviation from this can greatly harm depositors and indeed the financial system.
1. First, let us assume banks announce that anyone who wants can stop EMI payments for six months and pay it after say two years or five years. Now wouldn’t every borrower take advantage of this? If a borrower is paying an EMI of say RS 10,000 a month, and claims moratorium for six months, it would make sense for him to invest that 60,000 in an FD at another bank or put it in a debt mutual fund. In two years the Rs 60,000 will earn him a neat Rs 8000, even at a nominal 7 percent return. He can keep that gain for himself and pay his Rs 60,000 to the bank after two years. Every borrower, including the largest of companies would want to grab this opportunity. And if every borrower says he won’t pay interest for six months, how will the bank pay interest to the depositors. That's why banks charge extra interest if you avail the moratorium.
2. We can also look at this delayed interest as the time value of money. Let us assume a person X has borrowed Rs 1 lakh from Y in March, promising to repay him at the rate of Rs 10,000 every month from April through the next 10 months. Now assume, because of COVID-29 he can't pay from April to September. So if X wants to pay this entire Rs 60,000 five years later, is it fair for X to just pay 60,000 to Y? It is unfair because, five years on, Rs 60,000 won't purchase the same amount of goods and services as it does now. Inflation at the rate of 5 percent a year will mean this kitty will purchase about 30 percent less than what it buys today. That's why, Y will charge X an interest for the delay. This is exactly what banks are charging -- an interest for the delay.
3. A third confusion in this case is in understanding what a bank is. A bank is not manufacturing profits out thin air. A bank is an intermediary which takes money from the saver (a little bit from the shareholder) and lends to a borrower. So if governments or courts interfere and force the bank to forego interest from a borrower, banks will end up paying the depositor that much less. How fair is that?
4. The court is hearing only the borrower. It is not hearing the case of the depositor, partly because depositors are usually less well-off and less savvy people. The typical borrower is a well-placed individual who has met all his basic needs and can afford to pay an EMI for a car or a house. The borrower may even be the proprietor of a large company who can afford to pay a lawyer all the way up to the Supreme Court. The typical depositor usually includes poorer people, who don’t know they are getting a lower rate of interest because the bank has to forego interest from a borrower, worse the depositor also may have lost his job due to COVID and may be depending on the interest paid on his savings to get by. Why is the COVID-19 pain of the borrower more important than the pain of a COVID-hit depositor? Worse, the typical depositor may be our aged grandparents 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?
5. There also appears to be a misunderstanding of which or whose money can be used for a public purpose like giving relief during a calamity. Governments collect taxes to help needy citizens. What the saver puts in a bank are his tax-paid savings. Those are his private earnings and only he has a right to the interest it earns. The interest on his savings cannot be used for so-called humanitarian purposes like helping a COVID-hit company.
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 not 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 must please heed their view in the interest of the country.
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First Published: Sept 6, 2020 8:02 PM IST
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