India's highest court will resume hearing Oct. 5 on whether banks can levy interest on loans during a moratorium, a ruling that could put billions of dollars of lenders' interest income at stake and plunge them deeper into a financial crunch.
The moratorium, first announced by the Reserve Bank of India in March and later extended to Aug. 31, was aimed at providing temporary relief to borrowers affected by the coronavirus pandemic, but they are still required to pay the principal amount, interest and interest on the deferred amounts for the period of the moratorium, referred to as interest-on-interest.
The Supreme Court is hearing several petitions seeking a direction to the government and the central bank to stop banks from charging interest on loans for the months the borrowers were under the debt relief plan.
Wipe out
If the interest on all loans was waived for the entire six-month moratorium, the amount is estimated at 6 trillion rupees, according to the government's Oct. 2 affidavit seen by S&P Global Market Intelligence. If banks were to bear this burden, it would about "wipe out" a substantial part of their net worth and threaten their survival, the government told the court, adding that was why a waiver of interest was "not even contemplated."
The government has offered to bear the cost of waiving the compound interest during the six-month period on personal, educational and housing loans up to 20 million rupees to give relief to small borrowers, according to the affidavit.
A complete waiver of interest on loans under moratorium "will have serious financial consequences [for banks] apart from moral hazard issues," said V.K. Vijayakumar, chief investment strategist at Geojit Financial. The loss of income "would impair the health of the banking system and adversely impact financial stability," he said, adding, while the pandemic has roiled borrowers' finances, "remedies should not be worse than the disease."
The impact is expected to be bigger for India's state-run banks, which are already saddled with weaker capital ratios and higher nonperforming loans. The state-run lenders have also lagged behind their private-sector peers in raising capital and are likely to remain dependent on government capital injections amid depleted market valuations. The government's finances are strained because of a shortfall in revenue collection, especially the goods and services tax, making capital infusion by the state in these banks difficult.
Limping back
Economic activities have resumed, but with still very high number of new cases of coronavirus infections, banks face a challenging outlook. India, which imposed one of the world's strictest lockdowns to slow the spread of COVID-19, reported the steepest GDP contraction among major economies in the June quarter.
"The economic challenges will result in a subdued credit growth for the banking sector this fiscal but it should pick up next fiscal as the economy revives," said Krishnan Sitaraman, senior director at CRISIL, a unit of S&P Global. The local rating agency expects the economy to contract 9% in the fiscal year to March 2021 and banking sector credit growth to stay less than 1%.
There will also be challenges to the banks' asset quality, Sitaraman said. The loan restructuring scheme will mean that a number of accounts that should have slipped into the nonperforming asset category this fiscal year will not do so now.
The top court's Sept. 3 order of not downgrading loans till it decides on the matter means that the moratorium continues, in effect. It "raises uncertainty over recovery efforts, so a timely decision is key," Jefferies analysts wrote in a note for clients on the same day.
Jefferies said the financial impact of the interest-on-interest, which it estimates at between 40 billion rupees to 50 billion rupees, may not be large. But "it is the collateral risks with respect to borrower behavior that we worry about more," it said before the government submitted its affidavit to the Supreme Court.
As of Oct. 2, US$1 was equivalent to 73.30 Indian rupees.