Judicious decision

SC judgment will end uncertainty in the banking system

The Supreme Court’s refusal to extend the loan moratorium period and a total waiver of interest payments is a big relief for both the banking system and the government. An interest waiver on this scale would have significantly impaired the banking system, with wider macroeconomic consequences. The government had earlier submitted before the court that if it were to consider waiving interest on all loans for the six-month moratorium period announced by the Reserve Bank of India (RBI) in view of the pandemic, the amount foregone would be more than Rs 6 trillion. If banks were to bear this burden, then it would wipe out a substantial part of their net worth, rendering most lenders unviable and raising serious doubts about their survival. The decision to lift the stay granted on classification of non-performing assets (NPAs) will lead to an increase in the level of bad loans to some extent, but it ends the prolonged uncertainty on the issue.

More importantly, the language and reasoning of the court should boost confidence. For instance, it noted that it’s not the function of the court to advise on matters of financial and economic policy where institutions like the RBI are fully competent. The court can only strike down directions issued by the RBI if they are unreasonable or violate the provisions of the Constitution. The judgment also said that courts are not advisors to the executive on matters of policy, which they are entitled to formulate. On the issue of interest waiver during the moratorium period, the court has noted that banks and lenders have to pay interest on deposits and their liability continues even in the pandemic. 

The court, however, granted relief on compound interest with the reason that once the moratorium was granted, non-payment of instalments cannot be termed as wilful default. Thus, there is no ground for charging interest on interest or penal interest. Besides, the court did not find any justification for the restriction on compound interest benefit for loans only up to Rs 2 crore. The court has directed that if banks have recovered penal or compound interest, it should be refunded or adjusted in the next instalment. The relief to borrowers will have a marginal impact and the cost will be borne by the government. 

The RBI had allowed lenders to extend a moratorium on payment of term loan instalments between March 1 and May 31. The idea was to provide relief to the borrowers during the pandemic. As the economic activity remained subdued, the moratorium was extended till August 31. Meanwhile, a number of petitions were filed in the Supreme Court, broadly seeking a waiver on total interest during the moratorium period, an extension of the moratorium period, sector-wise relief, and waiver of compound interest during the moratorium period. According to the RBI’s projection, gross NPAs in the banking system could expand to 13.5 per cent by September under the baseline scenario. Bankers have argued that the impact of the pandemic has been less severe than anticipated. The actual picture would only become clear after the first quarter of the next fiscal year. Although it came a bit late, the judgment is another step forward towards economic normalcy.