A Case Against Loan Waiver

Financial literacy must go hand in hand with financial inclusion programmes. People should be educated about banking habits and practices and also their minds should be emptied of irrational ideas such as waivers. Dr Manas R Das In order to protect the borrowers hit by Covid-19, RBI recently allowed them moratorium of six months, in two phases, to repay their loans. However, an PIL has been filed in the Supreme Court to waive the interest accrued during the moratorium period. It is estimated that if the interest is waived, then the banking system could lose colossal sums which it can ill afford at the present juncture. Basically, banks are ‘financial intermediators’, i.e., they collect deposits from potential savers and lend the same to potential borrowers after meeting certain regulatory requirements. Both the deposits mobilized and loans disbursed are for specified periods of maturities, which are synchronous, closely, but not exactly. The rate of interest charged from borrowers is higher than the rate paid to depositors – the differential, called the ‘net interest margin’ or ‘spread’, is used by a bank to meet its cost of intermediation and generate profit. A bank promises depositors to pay interest on their deposits as per the specified time schedules and return the principal along with accrued interest, as and when those mature. Similarly, a bank requires borrowers to repay their loans with interest at stipulated intervals. The money repaid by borrowers is utilized (along with fresh deposits collected) for re-lending to borrowers, both new and old ones with good track record. This is called the ‘recycling’ of funds. Therefore, if borrowers do not repay their loans as stipulated by a bank, two things happen: wp:list the bank will not be able to pay the periodic interest as also the maturity amount promised to its depositors. This will scare depositors (both existing and potential) to save in that bank. Besides, the bank will,normally, lose its moral courage to solicit new deposits.as interest income decelerates or stops, the bank’s profit declines and further, with the asset financed eventually becoming non-performing, as per the prevalent accounting norms, the bank will have to make provisions. Combined together, these will erode the bank’s net worth, which, if not compensated through recapitalization, will ultimately result in the bank’s failure. /wp:list The scenario, when extrapolated for the entire banking system, would mean several banks failing and making the banking sector unstable and putting an end to the ‘financial intermediation’ process in the economy. In other words, there will be no deposit collection, nobody will get loans, and the economy will come to a halt. Thus, repayment or recovery of any loan is a vital component in a bank’s ‘financial intermediation’ function, which, unfortunately and pathetically, the public fails to appreciate because of their ignorance about what a bank does, and how it does. Therefore, financial literacy programmes must go hand in hand with financial inclusion programmes,aggressively, aiming at not only educating the people about banking habits and practices but also emptying their minds of such irrational ideas as waivers. About the Author:Dr. Manas R. Das is a former senior economist of State Bank of India. He has over 30 years of experience as an economist in two large commercial banks. Academically, he is a gold medallist in Bachelor of Arts with Economics Honours from Utkal University, followed by Master’s in Economics from Delhi School of Economics and Doctorate in Economics from Gokhale Institute of Politics and Economics. He is also a Certified Associate of Indian Institute of Bankers. He has won several awards, besides being a prolific writer.