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Economy

No interest on interest: What is it going to cost the government?

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We’ll take the hit, says the government, on the “interest on interest” waiver. After providing a moratorium on payments of loans, it soon became evident that this is no real favour – because interest would have to be paid on the money, just to be paid later. (Read: 3 months of no EMIs, but why you should pay anyways)

The moratorium had been extended to 6 months in length, and what happens is:

  • If you don’t pay any money back, principal is due (but not overdue, because of the moratorium)
  • But interest just keeps getting added
  • The interest for the first month adds up to the principal of the second month
  • Which means the second month’s interest is a little bit more.

A lot of people thought “moratorium” means “we don’t need to pay any interest”, and filed court cases to clarify. And the Supreme Court decided to hear the case. As part of this case, the government has now decided to provide a little bit of relief, but not too much.

What’s the problem?

The sheer size of it. If you waive all interest, the government claims that the amount lost would be a massive 600,000 crores.

If the Government were to consider waiving interset on all the loan and advances to all classes and categories of borrowers corresponding to the six-motnh period for which the moratorium (i.e. deferment of payment of instalment) was made available under the relevant RBI circulars, the etimated amount is more than Rs. 6 lakh crores.

This is from the affidavit submitted.

The total amount of loans in the system is roughly 105 lakh crores. At an average rate of 10% you might see a 6 month period of interest adding up to that number. (including compound interest)

Specifically, they say, for SBI, India’s largest bank: “a waiver of six months’ interest would completely wipe out over half of the bank’s net worth”. 

Plus, of course you can’t deny depositors their interest. A bank then is in a position that it has to pay depositors but not get interest from its loans, which is a dead-end situation.

Waiving of “Compound” interest

The Government has thus proposed that :

  • “Interest on Interest” is an extra burden, so let’s waive that part off
  • Simple interest is still paid by the borrower
  • And it’s only for select borrowers
  • Banks still can’t take the hit, so the government says it will take the hit
  • Meaning, it will pay banks the “interest on interest” amount
  • This applies even if you haven’t taken the moratorium so it’s for everyone that qualifies

But this will only apply to loans below Rs. 2 crore, and then, only on the following categories:

  • MSMEs
  • Education loans
  • Housing loans
  • Consumer Durable loans
  • Credit card dues
  • Auto loans
  • Personal loans (to professionals only)
  • Consumption loans

Wait, How Much Relief Does This Give?

Let’s say you have a Rs. 50 lakh loan outstanding, at 10% interest. Here’s a quick look at how interest on interest adds up. This is if you don’t pay back any principal.

Interest Calc

 

Essentially, it’s like this:

First, the total outstanding balance is now Rs. 52,55, 267. The total interest adds up to Rs. 255,267.

The government will pay Rs. 5,267 to your bank, so you get that much benefit.

Therefore the net benefit to you is still Rs. 5,267 but you must pay the interest of Rs. 250,000 on your own.

This doesn’t sound like much, and it really is not. The amount is roughly 0.1% of the outstanding loan. 

But that’s for an interest rate of 10%. What about for higher rates?

If you go to 15% interest, A similar calculation shows the interest-on-interest adds up to about Rs. 12,000 or 0.24%.

For 18% interest rate, the hit is 0.36% of the loan amount.

How much will the government have to pay?

The total loans outstanding by banks to various sectors highlighted above are about 36 lakh crores.

Sector Loans

 

First we have to assume that ALL of these are less than Rs. 2 cr. each. But that may not be true. Many such loans are more than 2 cr. such as certain MSME loans.

Second, some of the NBFC loans will be on-lent to customers who don’t qualify (to say real estate developers and so on). We consider the NBFC loans because what banks lend to NBFCs, they further on-lend to customers.

Third, the credit card “outstanding” includes customers who don’t pay any interest i.e. who will pay back before their due dates. Such customers won’t qualify for a moratorium, so the actual numbers that qualify will be lower.

Given the above, the qualifying amount of loans for the waiver is likely to be Rs. 30 lakh crores.

If we assume an average interest rate of 15% overall, the government will probably have to pay about Rs. 7,200 cr. (0.24% of the amount)

That’s not a huge deal by any standard, and the government can bear this quite easily.

Note: There are complexities. Banks will have to really work hard to calculate the actual amount of interest on interest applied. For instance, if you paid your EMIs on time, the interest on interest component for you is zero, because no interest was carried over. If you paid only a few EMIs, then the interest-on-interest amount will be less than 0.1%. And so on.  The actual amount might be much lower.

So….What?

Hit to Government: Rs. 7,000 cr. or so.

Savings to you: About 0.1% to 0.25% of the loan amount.

In all, this is good headlines, but the value for you is very little if you’re a home loan customer. The hit on the government is tiny.

What happens to everyone else? Well, they renegotiate with banks. RBI has allowed them to do so without carrying an “NPA” tag on their back.

The court takes the final decision, as is unfortunately the case with a lot of things that should have been decided in parliament or by the executive. Let’s wait for next week when the final decision comes out.