-Financial Services Division (firstname.lastname@example.org)
The Supreme Court of India (‘SC’ or ‘Court’) had given its judgment in the matter of Small Scale Industrial Manufacturers Association vs UOI & Ors. and other connected matters on March 23, 2021. The said order of SC put an end to an almost ten months-long legal scuffle that started with the plea for a complete waiver of interest but edged towards waiver of interest on interest, that is, compound interest, charged by lenders during Covid moratorium. While there is no clear sense of direction as to who shall bear the burden of interest on interest for the period commencing from 01 March 2020 till 31 August 2020. The Indian Bank’s Association (IBA) has made representation to the government to take on the burden of additional interest, as directed under the Supreme Court judgment. While there is currently no official response from the Government’s side in this regard, at least in the public domain in respect to who shall bear the interest on interest as directed by SC. Nevertheless, while the decision/official response from the Government is awaited, the RBI issued a circular dated April 07, 2021, directing lending institutions to abide by SC judgment. Meanwhile, the IBA in consultation with banks, NBFCs, FICCI, ICAI, and other stakeholders have adopted a guideline with a uniform methodology for a refund of interest on interest/compound interest/penal interest.
We have earlier covered the ex-gratia scheme in detail in our FAQs titled ‘Compound interest burden taken over by the Central Government: Lenders required to pass on benefit to borrowers’ – Vinod Kothari Consultants>
In this write-up, we have aimed to briefly cover some of the salient aspects of the RBI circular in light of SC judgment and advisory issued by IBA.
(updated based on the IBA Advisory dated April 19, 2021)
Applicability on Lenders:
1. Which all financial institutions are covered by the RBI Circular?
The RBI Circular is directed to the following lenders :
- All commercial banks (including Small Finance Banks, Local Area Banks and Regional Rural Banks)
- Co-operative Banks- Urban Co-operative Banks, State Co-operative Banks and District Co-operative Bank
- All India Financial Institutions
- All Non-Banking Financial Companies (including Micro Finance Companies, systemically important NBFCs, non-systemically important NBFCs and Housing Finance Companies)
2. What exactly is the relief to be given?
The Relief is relief against compound and/or penal interest for any failure to pay, or delay in payments, by the Borrower, during the Moratorium Period, that is, 1st March 2020 to 31st August, 2020.
Thus, the compound interest and/or penal interest charged, explicitly or implicitly, during the Moratorium Period, for payments which were either delayed or failed during such period, will be replaced by simple rate of interest, at the rate contractually fixed between the parties.
3. How exactly is the relief to be given?
The Relief may be given by either refunding the amount of relief to the Borrower, or adjusting the same against any dues payable by the Customer. In case there are any payments already due, the Lender generally has the right to appropriate the amount payable to the Borrower against amounts which have already fallen due under the facility.
4. I was not a party to the litigation in the Supreme Court, and therefore, can it be contended that the SC has passed an order against all financial institutions, even if they were not before the Court, and therefore, had no opportunity to make or plead their case?
Pursuant to the Supreme Court Order, the RBI had issued a circular on April 7, 2021 directing all lending institutions (specified above) to abide by the instructions of the SC. Hence, irrespective of a lending institution being a party to the SC order, the RBI Circular is intended to be implemented uniformly by all lending institutions.
Of course, it remains a contentious question as to who shall take the burden of the Relief – whether the lending institution itself shall bear it, or lay the claim on the government. Pending clarity on that, we are assuming that the lending institution will have to shoulder the burden of Relief.
5. I am an investment company; I don’t have loan transactions with the public. Am I covered by the RBI Circular?
Pure Investment Companies, though registered as an NBFC, may not be carrying out lending activities. Hence, there does not seem to be any actionable on their part under the RBI Circular
6. I am an NBFC; my borrower has given an explicit waiver that the borrower does not want to avail the benefit of Relief on compounding interest. Do I still have to give that relief to the borrower? Can my policy, for example, say that the benefit of compound interest relief will be given to all borrowers, except those who have explicitly waived off their right to the same?
The benefit under Supreme Court order is to be extended to all the Eligible Accounts (covered in FAQ 8) uniformly. The burden of refunding the interest on interest amount to the customer, is on the lender. It seems counter intuitive that a Borrower will waive off what is clearly for relief to the borrower. Such waiver by the borrower will give rise to apprehension of use of pressure tactics.
7. I am a retail lender and none of my borrower accounts had outstanding loan facilities of more than 2 crores as on 29 February 2020. I have already extended the interest on interest benefit to my customers under the ex-gratia scheme. Do I still have to comply with the actionables under the RBI Circular?
In cases where the outstanding amount for all the loan accounts of the lender were below 2 crore as on 29 February 2020, there may be 2 reasons why the 7th April circular may still have to be complied with:
- The benefit was not extended to a Borrower, though the Borrower was eligible for the same.
- The benefit was not extended to a Borrower, if the Borrower belonged to the classes which were not eligible for the relief under ex-gratia owing to aggregate exposure of such borrower to all the lenders being more than Rs. 2 crore.
Hence, a Lender may see whether there is any actionable, including any provision to be made in the financials of 20-21.
8. Which all classes or categories of loans/facilities are eligible under the RBI Circular?
All “standard accounts” have to be given the benefit of relief. The determination date for this purpose is 29th Feb., 2020. That is, the days past due (DPD) status should be less than 90 DPD as on 29.02.2020 (“Eligible Accounts”). While NPA classification is mostly done on account of DPD, there should not have been any other reasons for which the account was classified as an NPA as on 29 February 2020.
Accounts not eligible for Relief under RBI Circular:
- Accounts classified as NPA as on 29 February 2020.
- Loan facilities which were charged with simple interest.
- Accounts already refunded interest on interest under ex-gratia scheme
- Non-Funded facilities (bank guarantee, Letter of Credit) not eligible for any refund.
9. Are non-performing assets as on 1st March 2020 ineligible for the Relief?
The IBA Circular creates a confusion by use of the following expression: “NPA Accounts as on 29.02.2021 (presumption being no interest or no compound interest is changed in case of NPA accounts).
The presumption that compound interest is not charged on NPA accounts is fallacious. While interest is not accrued for accounting purposes, contractual right of the lender to charge interest continues even while the loan is an NPA.
However, the question is, was an NPA borrower actually eligible to avail the moratorium at all? The intent of the moratorium was to grant relief against difficulties arising due to the pandemic.
10. In case the lender is collecting EMIs and not charging any penal interest, will such loans be eligible?
The language of the RBI Circular para 2 is that all lending institutions shall immediately put in place a Board-approved policy to refund/adjust the ‘interest on interest’ charged to the borrowers,irrespective of whether moratorium had been fully or partially availed, or not. The RBI Circular intends to provide a relief on ‘interest on interest’ charged to the borrowers during the moratorium period, i.e. March 1, 2020, to August 31, 2020. That is to say, the intent of the RBI, following the directive of the SC, seems to give relief to a borrower who has been charged compound interest during the Moratorium Period.
Now, assume the following situation: A borrower did not avail of the moratorium, and was regularly paying loan instalments, and interest on the outstanding principal during the Moratorium Period. As there were no instalments that were overdue during the period, the question of the lender charging any interest on interest did not arise. Interest was being charged, but that was on the outstanding principal. Hence, if no compound interest has either been charged or posted to the account of the borrower, no benefit/refund is applicable to such borrower.
11. In the answer to the question immediately above, will it make any difference if the loan agreement provided for payment by EMIs rather than by equal instalments of principal or interest?
In EMIs too, the interest is inherently computed on outstanding principal (POS), and as there was no deferral of payments by the borrower, there was no interest on interest charged during the Moratorium Period.
12. Para 1.1 of the IBA Circular dated April 19, 2021 says : “where compound interest/interest on interest/ penal interest for non-payment/delayed payment was applied during moratorium”. This seems to imply that the relief is applicable only where (a) there has been a non-payment or (b) there has been a delayed payment during the Moratorium Period. In line with the SC ruling, the non-payment or delayed payment may either be covered by the mutual moratorium, or there may not have been a moratorium and still there may be a delay in the payments.
In essence, it seems from the reading of the IBA Circular that there are 2 conditions to be satisfied to grant the relief:
- Either a delayed payment or non-payment during the Moratorium Period, or there was a moratorium period availed and granted, and therefore, the compound interest was imposed on the restructured payment schedule
- And, the Lender has charged either compound interest or penal interest or both on account of either the delay, or non-payment, or shifting of payments due to the Moratorium.
Is it a correct interpretation to say that the relief under the IBA Circular is not applicable where the first or the second condition is not satisfied?
Yes, this understanding is correct. In fact, it becomes even clearer by reading the “remarks” column against entry 1, where it says, “Account eligible for refund only if compound interest/interest on interest/penal interest has been applied during the moratorium.” A similar comment appears against entry 2: “Accounts where compounding interest/interest on interest/ penal interest for non-payment/ delayed payment has not been applied during the moratorium will not be eligible for refund of interest.”
13. The facility in question did not have any payments due during the Moratorium Period. As there was no payment due during the Moratorium Period, the question of any compound interest or penal interest charged during the Moratorium Period, for payments delayed or failed during such period, does not arise. The following are some examples:
a) A loan was extended on 1st Jan., 2020 and the instalments were to begin from 1st October as the loan was under original moratorium.
b) A loan was given on 1st Jan., 2020 but a bullet repayment at the end of 1 year.
In both the cases, the intrinsic computations involve compound interest but as there was no failure to pay or delay during the Moratorium Period, there was no implication on any of the payments to be made by the borrower. Further, since no payments were due, the question of any moratorium did not arise.
In these cases, is it correct to contend that the 7th April circular does not apply?
Yes. As there is no case of delay or failure to pay during the moratorium period, there is no case for applying the 7th April circular.
14. The loan was standard as on 1st March, but was already 60 DPD as on that date. Hence, the overdue instalments were already attracting a penal rate, say at the rate of 24%. From 1st March to 31st August, can such penal interest, on instalments due and payable before 1st March, 2020, continue?
While it is possible to have a different interpretation, the intent of the SC ruling and the RBI Circular is that the time clock had stopped during the moratorium. The borrower could not pay till 1st March 2020 – that was a case of failure to pay. However, during the moratorium period, it was a case of inability to pay due to a supervening difficulty. Hence, neither compound interest nor penal interest can be charged during the Moratorium Period.
15. In case a lender does not charge compound interest on loan, will such loans still be eligible for refund/adjustment?
In cases where the lender does not charge compound interest on its loan facilities, this essentially means that there is no compounding of the principal amount by such lender over the tenure of such loan. Hence there is no question of refund of interest on interest on such loan facilities. However, if any penal interest has been charged with respect to such loan facilities, during the moratorium period, the same is liable to be refunded.
16. In case a borrower did not avail the moratorium in respect to the loan facility and such borrower defaulted on its EMI during the moratorium period, will such borrower be covered under the RBI Circular?
The refund of interest on interest is available to the Borrower under RBI Circular, irrespective whether the moratorium has been availed or not by such Borrower. A Borrower who did not avail the moratorium and subsequently defaulted on its EMI.
Then in such cases:
- Either the account is subjected to penalty on its EMI after such default by the customer, OR
- In case no penalty is charged, even in such a case EMI includes a compound interest component
Therefore, in cases where penalty is charged during the moratorium period all the amount towards penalty including interest on such penalty (if any) should be refunded/adjusted by the lender in addition to the differential amount payable in respect to interest on interest ( Six months compound interest on amount outstanding as on 29.02.2020 minus simple interest on amount outstanding as on 29.02.2020).
17. Will guarantee arrangements be covered under the RBI Circular?
Guarantee is an unfunded support. Hence, there is no question of any payments due, except for payments for by way of guarantee commission.
The IBA clarification dated 19 April 2021 clearly provides in its annure 1 column 2 that non-funded facilities are not eligible for refund.
Note that guarantee commission is not subject to a moratorium
18. Will it make a difference if the guarantee has been invoked and become a funded facility?
If the guarantee is a funded facility, on account of the guarantee having been invoked, it will certainly be covered by the Circular.
19. Will the accounts not eligible for benefit under the ex-gratia scheme, qualify for the refund of interest on interest under RBI Circular?
The ex-gratia scheme excluded certain accounts out of its ambit, such as agricultural and allied activities loans including tractor loans. The RBI Circular makes no distinction on such basis, hence interest on interest benefit should be passed to all the Eligible Accounts even if they were ineligible earlier under the ex-gratia scheme.
20. Will the loan facilities by banks to NBFCs/HFCs, qualify for the refund of interest on interest under RBI Circular?
The RBI Circular does not distinguish the loan accounts on the basis of end-use or the purpose of the loan account. Therefore, Eligible Accounts should also include loan facilities extended by banks to the NBFCs/HFCs, or loan facilities by one NBFC to another NBFC provided there was delay or failure to pay during the moratorium period and interest on interest or penal interest was charged.
21. Which all borrowers are eligible to be benefitted under the RBI Circular?
All borrower accounts that are eligible, have aggregate fund based activities with all the lenders of Rs. 2 crore and above and below. Subject to following conditions:
- Such accounts were not NPA as on 29 February 2020
- The interest/EMI on the borrower account is based on compound interest
- Interest has been charged on such interest/EMI payment during the moratorium period, either penal interest for delayed payment or non-payment has been charged on such interest/EMI.
- No refund of interest on interest was provided under ex-gratia scheme to such account.
22. In case an Eligible Borrower was not extended the benefit under the Ex-Gratia Scheme due to any reason, (such as non availability of bank account details for borrowers whose loan account have been closed), can the borrower avail the benefit under the RBI Circular?
All the Eligible Accounts of the Borrowers should be entitled to refund/adjustment of interest on interest under the RBI Circular, even if no benefit to such accounts was granted under the ex-gratia scheme.
23. What will be the eligibility of a borrower who has not availed any moratorium?
The fact that the borrower has availed the moratorium, or not, is inconsequential for the purpose of RBI Circular. All Eligible Accounts, whether moratorium was availed, or not, are entitled to refund of interest on interest for the period commencing from 01-03-2020 till 31-08-2020, provided there was delay or failure to pay during the moratorium period and interest on interest or penal interest was charged.
24. How will the computation of the relief be done?
(a) Identify the sums which have been failed or delayed during the Moratorium Period (Unpaid Amounts).
(b) Compute, based on actual rate charged, the compound interest and/or penal interest (Actual Charge) on Unpaid Amounts.
(c) Compute, on Unpaid Amounts, simple interest at the contractual rate of interest. Note that the contractual rate of interest may itself be a compound rate. There is no need to transform the compound rate into an equivalent simple interest rate. The compound interest rate itself may be applied on simple interest basis.
(d) The difference between step (b) and (c) is the Relief.
25. On what date is the Borrower entitled to get the benefit of the Relief? If the credit of the amount of Relief is to be given at the end of the Moratorium Period, then the compound interest charged on an amount equal to the Relief may have extended beyond the Moratorium period too.
In our view, the intent of the SC ruling followed by the RBI Circular is that the compound interest ought not have been charged at all during the Moratorium period. If the compound interest has been charged during the Moratorium Period, it will obviously have impact after the moratorium period too. In our view, the credit, therefore, has to be given at the end of the Moratorium Period.
26. On what rate of interest will the difference between compound interest and simple interest be calculated?
The difference between the compound interest and simple interest shall be calculated on the contractual rate (loan agreement rate) between the lender and borrower as on 29 February 2020.
27. Will there be any refund/ adjustment in case the contractual rate of interest is 0%?
In case the contractual rate is NIL or 0%, there is no question of granting any benefit to the borrower, given that the borrower has not paid any interest at all.
28. What is the exact manner of passing on the benefit to the borrower? Is it merely a credit to the account of the borrower, or does it lead to any cash benefit being transferred to the borrower?
The benefit has to be passed on to the borrower by either adjusting the differential amount with the future payables by the borrower or in case the loan account has been closed, the amount shall be refunded to the borrower. In either case, the lender is required to create a provision in its books of accounts for the financial year ending March 31, 2021.
29. When is the impact of such relief to be recognised in the books of accounts of the lender?
As per the RBI Circular, lending institutions shall disclose the aggregate amount to be refunded/adjusted in respect of their borrowers in their financial statements for the year ending March 31, 2021.