Last week, RBI Governor Shaktikanta Das also intervened on the side of the borrowers. Justly.
Banking begins with depositors: people who place, if you think about it, a disproportionately large trust in those who set up the banks. They pledge their savings to banks without much recourse or collateral, essentially a kind of unsecured loan, backed only by an institutional / regulatory structure for your convenience. (This year alone, the deposit insurance available to borrowers rose to Rs 5 lakh from the paltry Rs 1 lakh earlier.)
Banks are highly leveraged and multiply their meager venture capital by attracting deposits. If only basic share capital is considered, the leverage could be up to 10 times for banks. No other industry can have such high leverage and yet raise funds.
Banks are allowed this special waiver because they perform the crucial economic task of financial intermediation: transferring surplus from savers to investors or borrowers who have a more productive use of those funds. This savings brokerage business will not scale or meet the needs of the economy if capital requirements remain high.
The risks of high leverage are mitigated through a strong regulatory regime to ensure prudent banking. This gives borrowers the convenience of entrusting their savings to banks. Borrower relief measures that undermine this trust, the very foundation of banking, can have serious consequences.
Brokerage firm Macquarie estimates total interest on default loans at Rs 2.1 lakh crore. There will be another 15 billion rupee bill if interest on accrued interest is waived. If this burden fell on banks, it would eventually fall on depositors: they would see much lower interest payments or no interest over a period of time. Of course, bank owners, who also contribute venture capital, would suffer if the banks suffer valuation losses.
Bank depositors are often the most risk averse: retirees who earn monthly income from deposits, those who save for the future, or simply keep savings safe in banks until needed. Denying interest to millions of those depositors to benefit a few lakh borrowers, as the RBI governor put it, can cause immense misery.
Of course, borrowers need help or else large-scale bankruptcy and stress can hit the economy. That, however, cannot be financed by depositors, since the consequences can be even more serious for the economy if the bank loses the trust of depositors.
WHAT IS THE SOLUTION?
The total amount that defaulted, estimated at about 25% of the banks’ loan portfolio, may not have been stressed. Some borrowers might have approached it with great caution. With the economy opening up, those borrowers may not need more support.
The only problem for otherwise viable borrowers is: should they be charged interest on the interest owed during the default period? There is no case for waiving the primary interest for such borrowers. It would also discriminate against borrowers who do not opt for a moratorium.
That leaves those who are really stressed out and still unable to pay off their loans. Rather than a one-size-fits-all solution or relief for all, a case-by-case approach is required. The RBI has provided a framework for the resolution of stressed assets based on the recommendations of the KV Kamath committee.
Forbearance loans should also be resolved within that framework to the extent possible. This could include tenure relief, debt-to-equity conversion, supplemental loans, or whatever is feasible for these businesses to work.
There will be some that will fail, but that is a consequence of Covid. Should the government step in to rescue them? So the question must be asked: is that the best use of public money in times of pandemic?
The only relief that can be provided is to waive interest on accrued interest and also government funds, rather than having already burdened banks take the hit.
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