A deferred free lunch for good conduct

The suggestion made by the Supreme Court that banks should not just allow borrowers to defer the payment of loan instalments due between March and August, but also waive the interest due during that period suggests that it is in the favour of a free lunch. But who pays the bill?

As we know, banks lend from their borrowings from depositors, and it comes at a cost. So if this suggestion is implemented the banks will continue to pay interest to their depositors but not charge any interest to their borrowers for 6 months. And the amount is significant at Rs 2 trillion. Banks, being commercial organisations, won’t pay this amount from their pockets. That means the government will have to bear the cost, which effectively means it will come from the taxpayers’ pocket.

One does not know whether the government will consider this proposal, either in full or part, but there is a huge “moral hazard”. Most financial advisers (including myself) have advised their clients that if the Covid Pandemic has not affected the stability of their cash flows too badly, they should continue paying the equated monthly instalment as usual. If there is some chance that the waiver proposal may be accepted, a borrower who pays his instalment is likely to lose out on the benefit that will be taken by others who chose to accept the moratorium. Hence, even those who would otherwise have paid their instalment on time would be tempted to delay their payments.

Retail and the smaller commercial borrowers with their exemplary payment record (nudged by the credit bureau) has been the backbone of the Indian lending system. If there is a “moral hazard” even here, it could well be a death blow.

Here is a suggestion that entails no concessions from the government, rewards good repayment behaviour and also adds to the lending sector’s long-term viability. The Reserve Bank of India can formulate a scheme that makes it compulsory for the lenders to provide prompt payment discounts in the form of waivers during the last few instalments of the loan. A larger discount should be available to those who pay promptly from March 2020 till the end of the loan tenure. A relatively-smaller discount could be given to those who avail the moratorium but pay promptly from September 2020 onwards. These discounts appear to be far larger than its actual value as it is in the future and hence, its present value is low. The added benefit is that even this discount is available only if the borrower had been prompt in his payments till February 2020 and continues to be so after September 2020, till the end of the loan tenure.

The biggest advantage to the lender is that good borrowers will not switch their loans to another lender and stick with it just to be able to avail of this discount. The lender is likely to make up for this discount in terms of lower non-performing assets in his books. And the economy, in general, will benefit from the incentive for prompt payment to borrowers. Hopefully, even the court may be satisfied by this “free lunch” that is only promised today but given in the future. More importantly, it is given only to those who behave well.
The writer is a Sebi-registered investment advisor 

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