Borrowers need fair rates, not just waiver

With portability, a large number of borrowers will move to a 1-2 percentage points lower rate and enjoy handsome savings

A petition regarding the matter of lenders charging interest for the six-month moratorium period granted to borrowers is currently being heard in the Supreme Court. The petitioners are demanding that the interest accrued during the moratorium be waived. The lenders have correctly argued interest cannot be waived as they continue to pay interest to their depositors. The six-month interest burden is too huge for the government to bear either. 

According to reports, a via media has been found. The government has reportedly agreed to bear the compound interest (interest on interest) for the moratorium period. The cost of this concession being provided to retail and MSME (micro, small and medium enterprises) loans of up to Rs 2 crore has been estimated at Rs 6,000 crore.

While any relief will be welcomed by borrowers, this one is like providing a spoon of water to a thirsty man. For example, on a 10-year MSME loan of Rs 2 crore with interest rate at 10 per cent, the EMI would be Rs 2,64,000. The compound interest and simple interest for the six-month period would be Rs 10,21,066 and Rs 10,00,000 respectively. The benefit for a borrower is Rs 21,066, less than 10 per cent of a single EMI. 

The benefit is even smaller on a 20-year home loan of Rs 50 lakh with 8 per cent per annum interest rate and EMI of about Rs 42,000. The difference between compound and simple interest for six months is only Rs 3,363, an insignificant sum for an individual borrower. Though the aggregate sum reportedly works out to about Rs 6,000 crore, it is unlikely to leave any borrower feeling grateful to the government. 

Instead, if the Reserve Bank of India were required to enforce a “loan portability” policy, the relief will be significant. In India “floating rate loans” mean that rates float upwards swiftly when market interest rates rise. However, when they move downwards, as they have in recent times, the interest rates for borrowers move downward with a big-time lag and never to the full extent of the downward movement in market interest rates. Banks were required to shift to the transparent external benchmark-based lending system from October 2019 under pressure from the Supreme Court. But most borrowers are either those who have taken loans before October 1, 2019, or from non-banking finance companies (NBFCs) who are not covered by these regulations. Though borrowers can shift their loans to other borrowers without any charge, in practice they are prevented from doing so by logistical barriers put up by lenders. A “loan portability” system, where the title documents are exchanged for payment from the new lender, would spur more borrowers to switch to the more transparent system. Most home loan borrowers would pay a rate that is 1-2 percentage points lower.  

Let us take the same example of a 20-year home loan of Rs 50 lakh at 8 per cent. The current rate for the same borrower is around 7.25 per cent. If he gets this rate (which he is perfectly entitled to) due to the ease of the loan portability system, then he will get an interest free six-month moratorium period plus a reduction in EMIs. All at no cost to the taxpayer. 

The cost of this magic is borne by the lenders. But then why should unfair practices be protected in the name of maintaining bank profitability? In any case, the profitability of private banks and NBFCs would be most affected. PSU banks would be less affected as the differential between rates charged from existing borrowers and new ones is lower in their case. I hope the petitioners in this case demand this relief.

The writer heads Fee Only Investment Advisers LLP , a Sebi-registered investment adviser