Billions at stake, Modi govt must find a middle path to resolve this banking crisis

Borrowers want a partial moratorium on interest payments during the lockdown period. Debtors can’t be dragged to court for defaulting on loans till March 31. Indian courts will rule on several contentious financial issues whose impact will be felt for years to come.

As the Indian economy returns to decent health and gets back on the growth path at a faster pace than expected, a new imponderable has emerged – one that can have a significant impact on the future of the country’s economy and its growth trajectory.

The Indian Supreme Court, the National Company Law Tribunal and the High Courts are expected to pronounce their judgments on a number of cases involving distressed assets and moratoria on loans during the period of lockdown. The amounts involved run into tens of billions of dollars.

The verdict could have a major impact on the health of the banking sector in India, have a bearing on the sanctity of commercial contracts and affect the faith of millions of depositors who remain the main source of funds for the Indian banking sector.

The background

Following the announcement of the total lockdown by Prime Minister Narendra Modi in March, the Reserve Bank of India (RBI) mandated a moratorium on repayment of loans for a period of three months. This was extended by another two months to August 31.

It was not clear at that time if banks would charge interest on the interest accrued but not paid during the period of lockdown-induced moratorium. The Centre clarified in October that borrowers of up to $266,000 would not have to pay compound interest on the above. This decision was taken to help mainly MSMEs that were facing a cash crunch as a result of the lockdown.

Then, hearing an application filed by some borrowers, the Supreme Court had, on September 3, directed banks not to declare any account – even those unable to service their loan repayment obligations – as non-performing assets (NPAs) until further orders.

The rationale behind these two independent but related decisions was the same: Provide relief to borrowers hit by the Covid-19 pandemic.

New conflict

These administrative decisions by the government and the RBI and the judicial pronouncements by the courts have had an unintended consequence: It has pitted the already beleaguered Indian banking system and its depositor base against mainly corporate borrowers.

There’s merit on both sides of the argument. Businesses and individuals forced to stop operations for more than three months cannot be expected to service their debt obligations as usual. At the same time, individual depositors, many of whom depend on their incomes from bank deposits for their day-to-day existence, will demand interest on their deposits on the due dates. And banks can honour their commitments to pay interest to their depositors only if they receive interest payments from their debtors.

So, the possibility that banks may be asked to write off a part of their interest dues for the period of the lockdown threatens to throw the entire Indian banking sector, which is battling a massive NPA crisis, under the bus.

The suspension on bankruptcies

Then, the Central government has extended the suspension of the Insolvency and Bankruptcy Code (IBC) by three months to March 31, 2021. This means, no bank, lender or creditor can initiate bankruptcy proceedings against delinquent debtors till that date.

The IBC was meant to provide banks and other creditors a fast-track method of resolving the problem of unpaid loans, forcing recalcitrant managements to honour their debt repayment obligations on time and to ensure that otherwise productive assets did not remain idle as a result of tussles between borrowers and lenders.

The government’s rationale for suspending the IBC is understandable – it wants to protect companies that have been impacted by the coronavirus-induced economic crisis.

Perverse incentive to default

But a blanket suspension of the IBC can provide unscrupulous managements with the perverse incentive to intentionally default on loan repayments secure in the knowledge that such actions will go unpunished.

Overturning written contracts

Both these measures – on the loan moratorium and the question of interest accrued during that period as well as the suspension of the IBC – in effect, rewrite the terms of the written contracts signed between the lenders and the borrowers at the time of signing the loan agreement.

By unilaterally changing the terms of the contract in favour of the borrower, these measures are providing a body blow to the country’s already weak credit culture.

Find a middle path

It is nobody’s case that borrowers don’t need protection at a time when the entire world is reeling under the impact of the Covid-19 pandemic. They do; and the government, the RBI and the Supreme Court have rightly taken up the matter.

But to pass on the entire burden to a particular class of lenders – banks and their depositor base – is also unfair, especially at a time when the country’s entire banking system is fighting for survival.

A middle path has to be found to resolve this crisis to everyone’s satisfaction. So, instead of robbing Peter to pay Paul – an early example of what we now call a zero-sum game – the authorities must immediately initiate an urgent dialogue between all the stakeholders to find a way out of this crisis.