Moratoriums, loan waivers vs credit discipline

Why do people pay off a loan? First, because they are bound by a loan contract to repay. If they break the contract, there could be retaliation in the form of a punishment or penalty. Second, if the loan is against a collateral, non-repayment can result in the loss of that collateral. Often, the value of the collateral is greater than the value of the loan. Therefore, it is better to repay rather than suffer a larger loss. Third, the repayment creates a good credit history. It becomes part of a public record, which is useful for securing future loans. Indeed, in the case of microfinance loans, which have no guarantee, repayment helps the borrower to remain in good standing in the eyes of the lender. Thus, the repayment guarantees the availability of repeat loans.

In informal markets such as the sale of vegetables, a loan could be taken out each day, used to buy produce in wholesale markets, sell them at retail, and repay the loan with interest at the end of the day. A fourth reason for reimbursement, particularly valid in informal markets, could be due to simple coercive power or the threat of physical damage. Finally, repayment of a loan could also be due to the moralizing value that non-repayment is a sin. Not repaying your debts is tantamount to sin. As we can see, there are many angles of loan repayment, and the sum of it all is called “credit discipline”.

The economy works if the discipline of credit is strong and entrenched among borrowers and lenders. This is what needs to be nurtured and strengthened to ensure that credit is available to all who need it. It is the creation of credit that leads to the expansion of economic activity and growth. A person can take out a loan for their education or buy a house. This represents a loan from one’s own future income, to build an asset (college diploma or a house) for the present. Likewise, a business can borrow to finance its working capital needs, or to increase its capacity and repay the loan from future profits. All of this rests on the foundation of strong credit discipline. The banking system is critically dependent on a culture of credit, so that despite legitimate defaults on loans (due to the business downturn), it can meet the needs of a growing economy.

So when repayment is interrupted by an official sanction, it becomes a very critical decision, with long-term and far-reaching consequences. So when a political decision is made to grant loan waivers to farmers, it has implications for the credit culture. First, it is unfair to the farmers who have worked hard to repay and avoid default. Second, with repetitions
waivers, it encourages behavior to ignore repayment discipline. Third, it makes bankers and lenders wary of lending altogether. This could lead to a credit crunch rather than an expansion.

But of course, in times of acute distress, there is no alternative to loan waivers like emergency medicine. Even in such cases, a moratorium or loan restructuring is preferable, rather than outright waiver. The first leaves open the possibility of reimbursement, by adjusting the schedule. If a waiver, which is less preferable, or a moratorium which is better for the credit culture, is decided by the government, then the lender must be compensated by fiscal resources, i.e. by the taxpayers. Will the taxpayer agree that it is in everyone’s best interest? What if the lender has been harmed by willful defaulters? What if there have been fraudulent loans based on collusion and corruption? Is it fair to place the burden of the resulting bad debts on taxpayers? Are public sector banks and cooperative banks more prone to defaults and fraudulent loans? How to improve governance and credit management in the public sector and cooperative banks? These are questions that go beyond the scope of this column.

The issue of protecting and nurturing the credit culture has become relevant due to a public interest dispute in the Supreme Court. The Reserve Bank of India, as the regulator of all banks, has authorized a six-month moratorium on the repayment of all term loans, including home loans, credit card arrears and other retail loans. It was a temporary measure to help borrowers overcome cash flow problems caused by the sudden shutdown of economic activity after the severe lockdown.
However, during the moratorium, interest and repayment costs accumulated. The total amount of loans affected is over Rs 38 lakh crore, so the accrued interest for six months itself is around Rs 2 lakh crore. This accrued interest, the payment of which has been deferred itself, is like a new loan, the interest charge of which in turn is approximately Rs 5,000 crore.

The applicants seek a waiver of interest on interest from the Supreme Court. It is tantamount to undermining the credit culture. Paying interest is like paying the time value of money. It is the interest income of banks that allows them to repay their depositors with interest on savings and term deposits. If this interest income is refused, the banks will suffer and will have to ask for a new injection of equity from their owners, the shareholders. With the Indian government being the largest shareholder in public sector banks, it is like asking taxpayers for help. So, we are back to square one. Rather than imposing an unfair burden on the banks, it is better for the government to take it squarely on its chin and provide relief directly from the public purse, which is taxpayer money. Otherwise, waiving interest will harm the established credit discipline and culture.
painfully over the years.

In the event of a recession, when the banking system may have additional bad debts amounting to Rs 4 lakh crore by next March, it is extremely important to protect banks from the adverse effects of waivers and moratorium extensions. As the RBI itself submitted to the court in its affidavit, the problem now calls for a comprehensive loan restructuring program through fiscal resources, rather than expanding waivers and vitiating the credit culture. It is imperative that the court recognize this greater danger.

The author is an economist and senior researcher, Takshashila Institution

The billion press

Posted on: Monday October 12, 2020 6:05 am IST