SC did well to allow banks to declare loans as NPAs, but not allowing them to charge penal interest was a bad idea
While the Supreme Court (SC) may have acknowledged it doesn’t have the expertise to encroach upon the turfs of financial regulators and the government, and would not want to involve itself in complex trade and commerce issues, the fact that the judiciary is ruling on banking practices is worrying. After all, the apex court has ruled that lenders cannot charge ‘interest on interest’ or compound interest on loans that were under moratorium between March and August last year. In its view, compound interest charged during the repayment holiday is akin to penal interest; in that sense, it has used its expertise to come to this conclusion and strayed into executive domain.
One could argue banks should be allowed to charge compound interest. These are commercial and private transactions entered into by banks and borrowers, and a default constitutes a breach of contract, calling for punishment of some sort. The government may have picked up the tab of some Rs 6,500 crore for loans of below Rs 2 crore when the court had restricted banks from collecting compound interest, but that does not mean the rules were not broken by borrowers. In fact, the government should not have stepped in to help the borrowers; it could have capitalised banks instead with the same funds and allowed banks to decide which borrowers they should assist.
Now, the amounts charged on this count—for any size of loans—need to be either refunded or adjusted in the borrower’s account. This will be a hit to banks if they bear this cost, even if it is not a big hit since just about 15% of borrowers in this category opted for the moratorium. However, it is not the amount or who pays that is important but the principle. Banks may not be paying depositors compound interest but that doesn’t mean they can’t levy the charge on borrowers; the decision sets a bad precedent and puts banks in a spot. Borrowers now have the upper hand, and will use this ruling to get away by not paying compound interest even if there is no major pandemic-like situation. Even if they believe the SC won’t change its mind, bankers should file an appeal; matters of policy must be left to the regulators and government.
The SC has done well to dismiss pleas from borrowers for any extended repayment holiday or any additional breathers for interest payments; it has also not allowed the period for initiating the resolution mechanism to be stretched beyond December 2020. The blanket moratorium was a bad idea; several bankers had voiced their concerns on how so many borrowers were opting for the moratorium even though they had the means to pay. Most critically, the SC has now allowed banks to classify non-performing assets(NPAs) they way they should be; it had passed an interim order last September saying accounts which were not non-performing as on August 31 could not be declared NPAs till further orders. Asking banks not to do so was a terrible idea because it not only made the balance-sheets less transparent, it also prevented banks from taking action against borrowers.
Lenders have been reporting pro-forma NPLs and have been setting aside capital by estimating potential losses, but there can never be a substitute for actual numbers. The court must credit the banks with the intelligence to deal with borrowers in the manner they feel is best. Bankers know their customers better than anyone else does, and also how to treat them. Moreover, there is a competent regulator in place to suggest any relaxations; overruling regulators is uncalled for, and suggests the judiciary believes they do not know their job.
The decision to disallow banks from classifying NPAs correctly was as bad as the government’s decision to suspend the IBC (Insolvency and Bankruptcy Code) for a year. Again, the government should not have interfered and let the banks take the call instead. The fact is borrowers in this country, have always been able to get away by going to court; since the laws were so weak, banks were always at the losing end. Now that the IBC has proved to be an effective piece of legislation, the government should enforce it without interruptions; else, the repayment discipline will be vitiated. Post the pandemic, we could see a spurt in insolvencies; lenders may need to take haircuts when these are sold to new owners, but capital cannot be blocked; it must be put to work and assets must be utilised efficiently. The SC did well to shut the back-door on mischievous promoters trying to retain their bankrupt businesses when, in a recent verdict, it ruled that a person ineligible to file a resolution plan under IBC can’t take recourse in Section 230 the Companies Act and do this, thereby making the IBC the overriding law. The government must now incorporate provisions to enable pre-packaged plans to facilitate resuscitating of stressed businesses. That would be a good way to celebrate five years of the IBC, by far the most significant law framed for the corporate and banking sectors.