Loan waivers are a double-edged sword

The first recorded instance of granting loans to peasants in medieval India dates back to the regime of Muhammad-bin-Tughluq (1325-51) when, to ameliorate the distress suffered by villagers, Taccavi loans were advanced. However, faced with rebellion and famine, these loans were written off by Firoz Shah Tughluq, the subsequent ruler.

Though farm loans have become a palliative instrument to ease the financial distress of farmers, they are ultimately political decisions.

The first nationwide farm-loan waiver in independent India was implemented in 1990 by the VP Singh-led government, and cost the exchequer ₹10,000 crore. The Agricultural Debt Waiver and Debt Relief Scheme, implemented by the UPA government in 2008, involved an outgo of ₹71,680 crore and also included a one-time settlement scheme for ₹10,000 crore. Since then, there has been a wave of such schemes by different State governments. Originally intended as a one-off instrument, the past two decades have seen such schemes announced with increasing regularity, signaling the chronic distress of the agricultural sector in India. Though farm loans have become a palliative instrument to ease the financial distress of farmers, they are ultimately political decisions.

Last month, on May 2, a case was filed in the Supreme Court by a businessman from Agra, seeking a directive to the Central government and the Reserve Bank of India (RBI) to waive interest on loans during the period of moratorium announced by the Central bank in March. The RBI had announced a three-month EMI holiday from March 1 on all term-loan repayments like auto, home, personal loan EMIs, etc, which it further extended to August 31. The petitioner argued that the lockdown had taken away his livelihood, and therefore charging interest on a loan taken during the moratorium defeated the purpose of permitting a moratorium on loans. The Supreme Court had earlier dismissed similar writ petitions filed by some lawyers on the grounds that the petitioners were not affected parties.

Central bank speak

During the hearing of the case on May 4, the Supreme Court had focussed on two aspects — no interest payment on loans during the moratorium period and no interest to be charged on interest. In its submission, the Central bank has stated “the benefit of the moratorium is not to waive any payment obligations to the borrowers; the benefit was intended to only provide for a brief interlude in payment pressures.”

The RBI in its affidavit has said that “the weighted average lending rate for banks as on December 31, 2019, was 10.4 per cent and the outstanding term loans were ₹59,52,192 crore. Assuming that a moratorium is granted to only 65 per cent of the outstanding, the …. total interest income thus foregone will be about ₹2,01,000 crore.”

Further, if the banks are required to forego the interest, the RBI has averred, “there would be huge consequences for the stability of the banking system.” Quoting case laws, the Central bank has asserted that “public interest has always been considered to be above private interest”, and must not be over-ridden by the “interest of an individual”.

Legacy issues

After bank nationalisation in 1969 and again in 1981, banks implemented various welfare measures actively pursued by the Central government, at times with political intent. After nationalisation, the government has forgotten that only a fraction of the money lent out by banks is theirs, in the form of equity; the rest comes from depositors! The scenario may have changed now, with government-owned banks partially owned by private shareholders.

"Banks being custodians of depositors’ money, need to be guided primarily by the protection of depositors’ interests”

In the past, whenever governments wanted to waive borrowers’ dues partially or fully, cheques had to be written for the amount. The Central bank has consistently raised its voice against such decidedly political moves on the grounds that waivers militate against a healthy credit culture.

While waivers are the government’s purview, the RBI’s role is in protecting depositors’ interest. In the above case, the RBI has also submitted that “the banks are commercial entities that intermediate between the depositors and the borrowers, and are expected to run on viable commercial considerations. Moreover, banks being custodians of depositors’ money, need to be guided primarily by the protection of depositors’ interests.”

As the Supreme Court decides the legalities of a general loan waiver for the moratorium period, the point is whether the RBI should issue a directive to the regulated banks to waive interest on loans for a specified period? As the Statement of Objects and Reasons to the Banking Regulation Act, 1949, says, the primary objective of banking legislation is the protection of the interests of the depositor. The RBI has to ensure that banks operate in a safe way so that depositors’ money is available to them when they need it.

Whose money is it?

The primary function of banks is to put the money of their account-holders to use by lending to others, who can then use it to buy a house, set up a business or send their children to college. Banks receive deposits guaranteeing a return to the depositors, and lend money to borrowers under different contracts and agreements. Forced dilution of contracts between the borrower and the bank may directly or indirectly lead to an inevitable abrogation of the contract between the bank and the depositor. Clearly, the case being heard in the Supreme Court is not only between the petitioner, the government and the RBI.

There is another very interested party who is neither directly present in the court nor legally represented, but is indirectly represented by the Central bank. The role of the RBI in this case is not only to preserve the stability of the financial system, it is also responsible for protecting the safety of depositors’ funds. Thus, the Supreme Court has to bear in mind the source of the money lent to the borrower by the bank under an agreement which, if breached for any public purpose as determined by the Supreme Court, would violate the trust of innumerable depositors who have placed their earnings in banks under another contract.

It can thus be inferred that funds borrowed and funds deposited are two sides of the same coin. One side of the coin cannot be pressured to change its facet and design without impacting the other. If the Supreme Court can consider the waiver of interest of borrowers during the period of the moratorium, will the same Court be amenable to decisions by banks to write down the interest payable to depositors during the same period?

(The writer is a former Chief General Manager of the Reserve Bank of India)