Loan relief | The government’s compound interest exemption regime: how it will work

The Indian government has issued guidelines to banks for the implementation of a waiver of compound interest or interest on interest for a period of six months between March and August 2020.

The Reserve Bank of India had proposed a moratorium on repayments during those six months to help ease the impact of the Covid-19 crisis, but banks continued to accumulate compound interest during those months. This was challenged in the Supreme Court. Urged on by the Supreme Court, the government devised a plan to forgo compound interest on loans below Rs 2 crore, whether the borrower has fully, partially or not taken advantage of the moratorium.

Details of the program were notified on October 23, with the government asking lenders to implement the program by November 5.

Who does the plan apply to?

The scheme applies to loans below 2 crore rupees in eight categories identified by the government. The accounts should not have been marked as non-performing as of February 29, 2020, according to the notification.

Categories identified include:

  • MSME loans
  • Study loans
  • Housing loans
  • Sustainable consumer loans
  • Credit card charges
  • Auto loans
  • Personal loans to professionals
  • Consumer loans

The program is applicable to all credit institutions, including banks, non-bank finance companies and housing finance companies.

How will the amount due be calculated?

The government notification states that the amount of relief should be calculated using the difference between simple interest and compound interest.

  • The plan requires an ex gratia payment by crediting the difference between simple interest and compound interest.
  • Period to be taken into account for the calculation of the ex gratia payment set at March 1, 2020 – August 31, 2020.
  • When making calculations, repayments to the loan account during the period should be ignored.
  • The interest rate would be considered the rate of the loan agreement. If the rate changes after February 29, 2020, it will not be considered for the plan.
  • In the event of a credit card contribution, the interest rate will be the weighted average debit rate applied by the card issuer for transactions financed on the basis of the EMI between March and August.
  • For cash credit, simple interest will be calculated on a daily basis at the rate in effect on February 29, 2020. Compound interest will be calculated on a monthly basis. The difference between the two will be credited to the customer’s account.

Will the regime be applicable to those who have not taken the moratorium?

The government has clarified that the scheme will be applicable regardless of whether a borrower of the specified category has taken the moratorium fully, partially or not at all.

“When calculating, repayments to the loan account during the accrual period will be ignored. This will make the approach of the credit institution uniform for all borrowers, whether or not they have fully or partially benefited from the moratorium… ”, indicates the government notification.

Who will bear the cost?

The government has made it clear that it will bear the cost. It is estimated that the program will cost the government Rs 6,500 crore.

Lenders have been invited to submit their reimbursement requests before December 15, 2020. These requests must be pre-audited by the auditor of the credit institution.

SBI will act as the nodal agency for the government, both to receive and settle complaints.

Lenders have also been urged to put in place a grievance procedure for the scheme.

Will it be easy for the banks?

CS Setty, Managing Director of State Bank of India, said that according to operational guidelines suggested by the government, the differential between simple and compound interest will be adjusted based on a borrower’s loan account.

SBI already has the necessary information on eligible clients and borrowers do not need to apply for the differential to be credited to them, Setty said. It would automatically be adjusted on their loan accounts.

Ashutosh Khajuria, executive director of the Federal Bank, said banks have already undertaken an exercise to calculate the amount of compound interest charged to customers between March and August. “This way, each bank has the necessary information on the amount owed to each customer. We don’t think there is a major effort needed from the banks on this, ”he said. Khajuria said some small lenders may not have the technical capacity to implement this transparently, but the number of borrowers will be smaller.

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