The Moratorium playout - Is an option slowly turning into a right?

As with most things these days, the COVID19 pandemic seems to have turned yet one more well-established concept on its head – that of the “Moratorium”. A “Moratorium” generally serves as succour for entities desirous of support in repayments of debt. It is usually met with a sigh of relief and in its normal course, leads to a win-win situation with a lending institution, such as a bank, enjoying more footfall in terms of loan takers and a borrower – a corporate or an individual, enjoying sooner access to more capital. But the present circumstances have thrown a spanner in the works.

The recent RBI announcement on the moratorium and its subsequent call to extend it till the end of August were welcome buttresses at a time like this when access to liquidity is an issue. As well-intentioned as these measures were, it really was in the nature of an option that was available to the borrowers, if they so chose. The hope was that the common man, who was already staring at an exacerbating unemployment scenario playing out in the country, and the corporates, who are really only looking gravely at the idea of survival would have more cash to tide over the tough times. However, recent events in the news seem to suggest otherwise. What, at first blush, was certainly intended to be an option, now seems to have snowballed into a right to waiver that some parties are now claiming it to be. The underlying issue of interest accrual in this 6-month period has brought to the fore the raging debate on whether or not this is a fair move.

Now, it is well established that a moratorium is in the nature of a deferment and not a waiver. Moreover, it really is an option available to a party that wishes to exercise it of its own volition. The presumption is that the moratorium period allows the borrowing party to set his/her house in order with the capital that has been loaned out thereby allowing the pressure of repayment to ease out. The consideration for the opting party is that post the moratorium, the repayment period begins with the instalments containing an interest element accrued in the moratorium period as well. From the bank’s perspective, this repayment becomes more crucial, particularly given the current NPA landscape in the country. Any defaults by the borrowers in paying back exert tremendous pressure on the bank’s books, which unlike the usual case in the world out there, considers these loan extensions as its assets. When this default happens, en masse, the broad financial system takes a hit and the bank, sitting at the fulcrum of a nation’s financial system, suffers even more so.

The primary source of a bank’s income is its interest margin between the rates it sets for its borrowers and lenders. The profits that remain are further reduced after paying for operational costs (such as employee salaries, electricals, rents, etc.), compliance costs (legal fees, etc.) and of course, taxes. The two broad problems that a bank faces in the event there is no receipt of interest from the borrowers are:

(i)            The cash inflow-outflow mismatch that would ultimately hurt its own balance sheet and may compel them to look for external sources of funding; and

(ii)           Additional costs in arranging for the funds to meet the demand from more borrowers

This conundrum is more pronounced in light of both, the recent judgments interpreting the applicability of the moratorium and the plea before the Supreme Court on charging of interest by the lenders during the moratorium.

Since the situation is evolving on a daily basis and the text of the RBI directive suggests that it is an option available to the lenders on whether or not they want to grant the moratorium, quite a few aggrieved borrowers have initiated proceedings against their lenders. The courts have contributed to this debate and the judgments pronounced by them have raised some serious questions. The first-mover on this was the Delhi High Court where the court granted relief to a borrower with respect to a default that occurred way back in January 2020. Focusing on the intent of the RBI directive, The Hon’ble Delhi High Court held that the moratorium announced by RBI must be granted. Thereafter, the courts have interpreted RBI directions liberally and made them somewhat binding instead of allowing them to be exercisable by the lenders in the relevant situation. In an extreme instance, one of the High Courts even held that a lender could not have even triggered an ‘event of default’ due to COVID-19.

Interestingly, while the RBI gave an option to the financial institutions to grant moratorium to the borrowers, it provided that the interest obligations of the borrowers remain intact. However, a plea has been filed before Supreme Court on the applicability of the interest in the moratorium which seems to have opened up a Pandora’s box by building a legal argument for a waiver. While the matter is still being heard by the Supreme Court, in one of the hearings it has observed that “while on one end you are granting moratorium, on the other nothing (no relief) on interest. This is more detrimental in such challenging times”. While at first, it appeared that the Supreme Court may seem to have gone beyond the issue at hand by revisiting the agreed commercials, the recent developments in the matter suggest that the court may have softened its stance after giving due consideration to the submission by the banks. It remains to be seen what consequences follow from the subsequent hearings – do the already fragile lending entities get a shot of relief or do they see their pains become more severe.

To be fair, there are equitable arguments on both sides. Some rightly suggest that the health crisis deserves paramount attention and if the waiver of interest in the moratorium period helps to allay any health-related fears, then so be it. But the other side makes a reasonable argument as well, in that steps taken for a waiver could result in us merely kicking the can of bigger economic problems down the road for later. This faction has also questioned whether the waiver should be used as a ‘one-size-fits-all’ remedy and if so, whether it should be provided only to the borrowers.

If a blanket waiver were to be provided, it would necessarily require adequate consideration of various problems that could stem from this action such as a possible mismatch of the internal cash flow and the treasury management of the lenders. The waivers will necessitate the lenders to re-evaluate the cost of borrowings which when increased, would, in turn, hurt the innocent borrowers who were otherwise adhering to the terms of their agreement and repaying on time. All this, coupled with the possible labelling of courts as “borrower-friendly” might exacerbate the already existing negative perception of India’s policy flip flops, thereby reducing the country’s appeal as a fitting investment destination to investors.

We must take cognizance of some hard facts. Our nominal GDP is not growing and doubting the ability of some borrowers to pay back is not without merit. Loan growths have plummeted. Priority number one for most corporates now is really survival through this pandemic, rather than any need for borrowing capital for new ventures. In the event that the moratorium measures metamorphose from an ‘option’ to a ‘right’ of the borrower, it may lead to dire consequences in an already frail economy. The onus would eventually fall on the government to salvage the economy and any government measure announced thereafter would be at the cost of the exchequer.

The COVID-19 pandemic has certainly been harsh on the world. As almost all nations announce a slew of measures to safeguard their respective economic interests, India too has come to the fore with its own basket of initiatives. As large as this basket is or needs to be (depends on which side of the fence you’re on), it would do well to add yet another item on that shopping list – clarity on the moratorium and the consequences stemming from it.

Note: This article has been written in collaboration with Dipanshu Singhal. The views are personal.