If banks do not receive interest from their borrowers, they would not be able to honour their promise to depositors to pay interest on their deposits.
By N. R. Bhusnurmath
Later this week (12 June) the Supreme Court will resume its hearing on a petition filed by a borrower (home loan) seeking waiver of interest on bank loans during the moratorium period. Earlier the Apex Court had granted time to Reserve Bank of India (RBI) and the finance ministry to file a joint response to a public interest litigation (PIL) on whether interest ought to be charged from borrowers if they availed the benefit of moratorium on loan repayment.
The Counsel for the RBI had argued that waiver on interest during the moratorium period on term loan repayment would jeopardise the financial health and stability of banks, as well as the interest of debtors. However, for now, the sympathies of the three-judge bench, comprising Justices Ashok Bhushan, MR Shah and SK Kaul, seemed to be with borrowers going by the Court’s remark, “Economic aspect should not be higher than health of people.”
Unfortunately, as the former governor RBI, D Subbarao, puts it, any such waiver would not only be detrimental to the health of the banking sector and jeopardise financial stability, it would be downright iniquitous between borrowers and depositors; both customers of the same bank.
It is important to remember that banks are only intermediaries ie they intermediate between depositors and borrowers. In simple words they take deposits from savers and use funds thus raised to lend to borrowers. And since in the real world there is no free lunch, banks have to pay interest to depositors and, in turn, charge (a slightly higher) interest on loans to their borrowers. The difference between the interest received from borrowers and that paid to depositors, or the net interest income is a major component of bank income. This NII takes care of the expenses of the bank and contributes to the profit of the bank.
If banks do not receive interest from their borrowers, they would not be able to honour their promise to depositors to pay interest on their deposits. The flip side of a waiver of interest on loans given to borrowers is inability to honour what is a contractual obligation to depositors. It would therefore be unfair to the depositors. As a result, it is quite possible that depositors will cease putting their savings in banks leaving the latter with no funds to lend.
Thus, the consequences of a waiver of interest on loans go much beyond the obvious. The Honourable Judges must understand that the RBI’s directive to banks enabling them to offer a moratorium (initially for three months and later extended to six months) is only meant to ease the cash flow crunch that may be faced by borrowers as a result of Covid-19 lockdown. It must not be confused with a waiver of the obligations under the loan.
The two questions, reportedly identified by Justice Bhushan, first, whether interest should be charged during the moratorium period and second, whether interest should be charged on the accrued interest, go to the very heart of banking as a business.
Yes, many borrowers will, perhaps, face hardship in adhering to the original repayment commitments. Hence, the case for a temporary balm by way of giving borrowers more time to pay. However, the balm can only be temporary; else the very viability of banks will be destroyed. Remember, even as banks give their borrowers more time to pay the loan instalment and interest and they will have to repay their depositors as and when the latter demand their money as well as pay interest on their deposits. On time!
So, banks are already taking a hit. It would be both unfair and against the grain of all commerce to expect more.
- N. R. Bhusnurmath is Adjunct Professor IMT Ghaziabad. Views expressed are the author’s own.