Compound interest

Loan relief | Government Compound Interest Waiver Plan: How will it work?

The Government of India has issued guidelines for banks to implement 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 mitigate the impact of the Covid-19 crisis, but banks continued to accrue compound interest during those months. This was challenged in the Supreme Court. Pushed by the Supreme Court, the government has devised a plan to waive compound interest for loans below Rs 2 crore, whether the borrower has taken advantage of the moratorium fully, partially or not at all.

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

Who does the scheme apply to?

The scheme is applicable to loans below Rs 2 crore in eight categories identified by the government. The accounts should not have been labeled as non-performing as of February 29, 2020, the notification states.

Categories identified include:

  • MSME Loans
  • Education Loans
  • Housing loans
  • Sustainable consumer loans
  • Credit card fees
  • Car loans
  • Personal loans to professionals
  • Consumer loans

The regime 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 provides ex gratia payment by crediting the difference between simple interest and compound interest.
  • Period to count for the calculation of the ex gratia payment fixed from March 1, 2020 to August 31, 2020.
  • When calculating, repayments on the loan account during the period should be ignored.
  • The interest rate would be counted as the rate in the loan agreement. If the rate changed after February 29, 2020, it will not be considered for the plan.
  • In the case of credit card fees, the interest rate will be the weighted average debit rate charged by the card issuer for transactions funded on an EMI basis 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 apply regardless of whether a borrower in the specified category has taken the moratorium in full, in part or has not taken it at all.

“During the calculation, repayments from the loan account during the counting period will be ignored. This will make the lending institution’s approach uniform for all borrowers, whether or not they have fully or partially taken advantage of the moratorium. ..”, reads the government notification.

Who will bear the cost?

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

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

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

Lenders have also been told to put in place a grievance redress for the scheme.

Will it be easy for banks?

CS Setty, Managing Director of State Bank of India, said that in line with the operational guidelines suggested by the government, the differential between simple and compound interest will be adjusted against the borrower’s loan account.

SBI already has the necessary information about eligible customers, and borrowers don’t need to request that the differential be credited to them, Setty said. It would automatically be adjusted against their loan accounts.

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