(Co-authored with Radhika Pandey)
The Covid-19 lockdown adversely impacted businesses and made servicing of debt difficult. As this was an outcome of government policy, some kind of support from government was expected.
The Government has issued guidelines to banks for implementing a waiver of interest-on-interest accrued on outstanding loans during the six month moratorium period. The interest-on-interest waiver will be applicable for loans upto Rs 2 crore and will benefit all borrowers regardless of whether they availed the moratorium or not. Under the scheme, the lender has to credit the difference between compound and simple interest to borrowers of specified loan accounts on or before November 5.
The question that arises is that should such support be extended to only those borrowers who do not have the ability to pay. Given the scarce fiscal resources of the government, one might have thought so. But such a move imposes a penalty on those who made timely payments and encourages moral hazard. If it is known that government will step in to waive off loans or interest payments, borrowers would stop making payments. This will adversely impact the credit culture.
Having a universal character of such scheme seems to be a better strategy when it is hard to identify within a stipulated deadline, borrowers who do not have the ability to pay.
Loan waivers such as the farm loan waivers are often argued to vitiate credit culture. But this scheme covers the interest-on-interest and not the entire principal or interest. Hence it is of a much smaller scale than the farm loan waiver schemes.
On 29th February, 2008 the then Finance Minister announced an unprecedented debt waiver scheme for small and marginal farmers (farmers holding upto one to two hectares of land). All formal agricultural credit disbursed by commercial and co-operative banks between between 1997 and 2007 came under the purview of this scheme. Under the scheme which costed the exchequer almost Rs 72,000 crore, all agricultural loans that were either overdue or were restructured as on 31st December, 2007 and continued to be overdue till 28th February, 2008 qualified for the debt waiver. Empirical research on the impact of the scheme seems to suggest that there was no improvement in the repayment behaviour of the waiver benficiaries. Expectation of similar debt relief in future generates moral hazard and strategic debt default. On the lending side, banks slowed lending in districts where the exposure to waivers was high.
An internal Working Group Report by RBI on agricultural credit observed that farm loan waivers by States have seen an unprecedented increase since 2014-15. While the rationale of debt waiver scheme is to alleviate debt related distress, it often undermines credit culture.
Some argue that while the grave implications of farm loan waivers on states budget and on credit culture are widely discussed and debated, the same should also be true for corporate debt default. It is true that both represent a moral hazard but the remedial measures for farm loans are different from corporate debt.
While in case of corporate debt, banks have some remedial measures such as the Insolvency and Bankruptcy Code (IBC) and corporate debt restructuring, farm loan waiver entails a direct fiscal cost to the government. Under the IBC, when a compaby defaults on its debt, control shifts from the shareholders/promoters to a committee of creditors who decide on the strategy to recover debt. The defaulting entity might end up losing the company if they don’t pay on time.
As part of measures announced to help businesses, the Government decided to suspend several provisions of the IBC to help firms that may be staring at a default due to the disruption in economic activity due to the Covid-19 pandemic. This seems to be an appropriate measure because due to the Covid-19 pandemic, lenders may not find enough buyers or investors unless the valuation is scaled down substantially, in that case lenders would have to take a deeper hair cut.
The one-time restructuring scheme announced by the RBI would help companies tide over the crisis. The scheme gives flexibility to lenders to frame resolution plans for personal loans which could include rescheduling of payments, conversion of interest into another credit facility, granting of moratorium etc. Eligibility criteria and timelines have been laid down for invocation of the resolution process. Since under the restructuring process, borrowers account would not be downgraded to sub-standard or non-performing, it would alleviate stress on banks balance-sheet even though they have to set aside higher capital for the restructured accounts.
In a previous column, we have talked about the difficulties related to public sector banks which may be reluctant to do so. Concerns of bank officials need to be addressed if these schemes are to succeed in getting the economy back on track.
A number of steps have been taken to help borrowers during these unprecedented times. The design and implementation of these measures should ensure that the possibility of moral hazard is minimised. In the absence of this, banks would be reluctant to lend and subsequent rounds of credit growth will take a hit. Ideally most loans would have to be renegotiated.
Ila Patnaik is Professor at the National Institute of Public Finance and Policy (NIPFP), New Delhi, and a former principal economic advisor to the Government of India, Radhika Pandey is a fellow at NIPFP.
This was originally published in The Print on 30th October, 2020.
The views expressed in the post are those of the authors only. No responsibility for them should be attributed to NIPFP.