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To provide relief to individual borrowers and medium and small industries, the centre told the Supreme Court that it is ready to waive compound interest (interest on interest) charged on loans up to Rs. 2 crores for a 6-month moratorium period. Individuals and Micro, Small and Medium Enterprises (MSMEs) will be eligible for a waiver of compound interest during the six-month moratorium from March to August 2020. 

Borrowers of loans like home loans, education loans, credit card dues, auto loans, personal loans, consumer durable loans, MSME loans, among others will be eligible for the waiver. The waiver on compounding interest would be applicable to the categories specified by the government, irrespective of whether the borrower has availed the moratorium or not.  

In an affidavit filed by Union Finance Ministry on behalf of the Union Government, it said “The government, therefore, has decided that the relief on waiver of compound interest during the six-month moratorium period shall be limited to the most vulnerable category of borrowers. This category of borrowers, in whose case, the compounding of interest will be waived, would be MSME loans and personal loans of up to Rs 2 crore.”

The affidavit further states that any individual or entity whose loan amount exceeds Rs. 2 crores will not be considered for a waiver of the compounding of interest. The government says it has decided to continue the tradition of hand-holding of small borrowers in view of the cumulative circumstances. As per sources, this waiver is expected to cost the government an estimated Rs 6,000-7000 crore

How your EMIs are affected by the waiver of interest on interest

A waiver on levy of compound interest on terms loans of up to Rs. 2 core may come as a big relief to borrowers, especially for borrowers whose loans are in initial years of repayment. The burden on borrowers will reduce significantly as they need to pay on the contracted rate of interest on loans.

Borrowers need to consider the following points to understand how their EMIs are affected by the waiver of the compound interest.

What borrowers have to pay?

As a loan borrower, you must understand the difference between interest and compound interest or interest on interest. Make it clear that you have to pay the interest on your outstanding loan for the period for which you availed the moratorium. For example, at the beginning of the moratorium period, if you had a loan outstanding of Rs. 50 lakh for a remaining tenure of 19 years and the interest rate applicable was 8% p.a. The interest cost for the moratorium period of six months would be around Rs. 2 lakh. Hence, you will have to pay Rs. 2 lakh as interest. 

What will be waived?

As the government has proposed to pay the compound interest, hence banks will not charge interest on Rs. 2 lakh interest amount (as described in the above example) from the borrower. As a result, the interest on the interest amount of Rs. 2 lakh will not be added to your principal outstanding of Rs. 50 lakh and banks will not calculate a fresh EMI at the prevailing interest.  

How much EMI would you need to pay now?

If you have got a 6-month moratorium and the government has agreed to pay the interest on the interest component, lenders can simply divide the interest component – Rs. 2 lakh in this case over 19 years or 228 instalments. It will increase your EMI by Rs. 877 per month. 

What is the difference in your EMI?

Considering the above example, if the government had not offered to pay the compound interest, your EMI would have increased by Rs. 1,709 per month for the remaining repayment tenure of 228 months. Since the bank is not adding the interest component to your principal outstanding, your monthly instalment would only be increased by Rs. 877. Hence, you can save around Rs. 832 per month for the period of 228 months, which amounts to Rs. 1,89,696 over the remaining repayment tenure. 

Downgrading of NPAs, credit rating

As far as the downgrading of loan accounts from standard to NPA (Non-Performing Asset) is concerned, the centre says that any account becoming non-performing even due to the bank’s or other delays, will not suffer from being labelled as NPA. In a relief to stressed borrowers who are facing problems due to the impact of COVID-19, the top court of the country has already made it clear that any loan account (standard on 31 August) would not be declared a non-performing asset (NPA) till further orders. 

The operation of a provision of the Insolvency and Bankruptcy Code, 2016 (IBC) has been suspended from March 25 to protect corporate borrowers impacted by the COVID-19 crisis.

Conclusion 

The Centre informed the apex court that waiving compound interest would lead to substantial and significant financial burden and it is impossible for the banks to carry the burden without passing on the financial impact to the depositors, which would not be in the larger national economic interest. Therefore, the Centre proposed to bear the burden resulting from a waiver of compound interest. 

The government waiver on levy of compound interest on loans up to Rs. 2 crore due to the COVID-19 pandemic and the suspension of Insolvency and Bankruptcy Code will provide major relief to an individual borrower and Micro, Small and Medium Enterprises (MSMEs).  

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