The Indian government is willing to bear the cost of the waiver of interest on interest charges on loans in the wake of the distress due to the pandemic.

The proposal seems well thought and middle class borrowers would rejoice the move if the Supreme Court rules in favour of this waiver. The apex court is scheduled to hear the case today.

But as there are no free lunches, there are no equal borrowers either. The upsides of the proposal itself pose a difficult endgame to credit discipline. We take a look at what the proposal means in five points:

Saving the Banks

The government has kept the benefit of the waiver limited to loans of up to 2 crore and said it wants to support only the small borrowers who are the most vulnerable. But this limit is borne more out of necessity to protect banks than to help small borrowers. If the compound interest calculated during the six-month moratorium period was waived off for all borrowers, including large corporates, banks would have hato forgo an estimated 6 trillion in interest income. To put it mildly, this could wipe out the net worth of the largest lender State Bank of India (SBI). Investors of banks are elated as reflected in the near 2% rise of the Nifty banking index today.

Forced Equality

The government has said it wants to protect only the most vulnerable borrowers. But no two borrowers are the same. A 2 crore home loan borrower likely has a different financial profile than one with 2 crore worth loans to run a small business. In the same way, a borrower with a large education loan has a different risk profile than one with a large credit card outstanding. The government’s proposal risks over simplifying the categories of borrowers and plugging them together despite their unequal profiles in vulnerability.

Discipline is Dumb

The most unpleasant fallout of the move is a miffed borrower who was disciplined enough to not take a repayment holiday. To be sure, the government has proposed to waive interest irrespective of whether moratorium was opted or not by the borrowers. Even so, the disciplined borrower may feel cheated for taking the trouble to pay off every month. As such, past waivers of farm loans have eroded credit discipline among such borrowers over time. The delinquencies in farm loans have been elevated, an indication of a weakening credit culture besides weak finances.

Paradox of Rift

At the outset, the government’s affidavit mentions only banks as beneficiaries of compound interest waiver. The intention is to protect depositors. Ergo, it is unclear whether the government seeks to subsidise non-deposit taking non-bank finance companies (NBFC). As such, micro finance loans have been kept out of the ambit. This goes against the government’s own statement that it wants to support small borrowers. Moreover, differentiating between banks and NBFCs would be unfair as both have retail and small business borrowers.

Win Today, Lose Tomorrow

There are no free lunches. The compound interest waiver has a cost and the government will need to shell out 5,000-7,000 crore as subsidy towards this waiver. But the government raises money through taxes and eventually the cost is borne by individuals. To be sure, protecting banks from forgoing compound interest is ultimately protecting the depositor. The government should be appreciated for this effort. Even so, every borrower or a depositor is also a taxpayer. There is a subtle warning by the government. "..the government bearing this burden would naturally have an impact on several other pressing commitments being faced by the nation, including meeting direct costs associated with pandemic management, addressing basic needs of the common man and mitigating the common man's problems arising out of loss of livelihood," the affidavit says. There needs to be a hard and long look of whether the taxpayer should be subsidising borrowers at all even if the taxpayer is also a distressed borrower.