Banking system on ventilator

Finally, the Reserve Bank of India (RBI) used its arsenal to fight out the economic battle in a global health emergency. The apex bank reduced repo rate by a massive 75 basis points (bps) bringing it to 4.4 per cent and also slashed cash reserve ratio (CRR) by 100 basis points to 3 per cent. The reverse repo rate, too, was lowered by 90 basis points. Notably, a cut of one per cent in CRR has unlocked Rs.1.37 crore primary liquidity in the banking system.

Even as the deep cut in policy rates would be translating into low interest rates, the three-month moratorium on equated monthly installment (EMI) payments of all term loans became centre of attraction for borrowers. The debate on EMI holiday has already gained momentum and banks have started facing the heat as many borrowers have complained about the deduction of EMIs in contravention to the standing instruction envisaged in the COVID-19 induced ‘RBI relief package’.

Before deliberating upon the issue, let’s first understand the arsenal which the RBI used together to fight the economic battle in the health emergency.

Repo rate is the rate at which the central bank lends money to commercial banks in the event of any shortfall of funds. Monetary authorities use this to control money supply in the economy, thereby inflation.

The reverse repo rate is the rate at which RBI borrows funds from commercial banks. It is the rate at which commercial banks in India park their excess money with RBI usually for the short term.

CRR or cash reserve ratio is the percentage of total deposits that banks are required to keep in reserves either in the vaults or with RBI so that the same can be given to bank’s customers if the need arises. Banks do not get any interest on this money. It is one of the major weapons in RBI’s arsenal that allows it to maintain a desired level of inflation, control money supply and liquidity in the economy. The lower the CRR, the higher liquidity with banks, which in turn goes into investment and lending and vice-versa.

For all practical purposes, in a pandemic situation which coronavirus has unleashed, monetary relief of any nature is a welcome step. And such a step, of course, helps the organizations as well as the individuals to fight economic battle in a human consuming health emergency situation. But the question is how far this temporary relief of three-month moratorium is going to help the borrowers in future.

So, the moratorium period in case of loans needs to be understood in right perspective. What does moratorium on loan means? It refers to the period of time during which you do not have to pay your loan installment, in banking parlance called EMI (Equated Monthly Installment) on the loan taken. This EMI holiday is granted under extraordinary situation when borrower/s are caught up in financial difficulties and such EMI breaks are anticipated by the banks to help the distressed borrowers to plan their finances better.

Moratorium holiday, of course, will provide relief to many individuals, especially the self-employed, as they would have found it difficult to service their personal loans, car loans, home loans etc due to loss of income during the prevailing crisis. But their repayment capacity will still bear question mark once the moratorium period is over. The things would be more challenging for those borrowers who have lost their income stream and are out of job.

First and foremost thing is that borrowers have to understand that moratorium is not waiver of loan. It’s simply deferment of EMI payments. India was already undergoing economic slowdown in pre-coronavirus outbreak period.  Fallout of the ongoing Covid-19 pandemic added more to the economic woes of the country as the slowdown got deeper to a common man. In fact, the health emergency caused in post-pandemic period fuelled the slowdown deeper and brought every sector of the economy into a grinding halt. This immediately impacted the incomes of individuals as well as the organizations and there is every possibility that the incomes might go further down in coming times.

While anticipating the situation, the RBI used tool of moratorium in its arsenal as a ventilator, both for banks and their borrowers. For banks, there is every probability that most of the loan portfolio might deteriorate as borrowers won’t be able to remain committed to their EMIs. The three-month moratorium will rescue banks from bad loan scenario. Precisely, it’s a ventilator for the banks to protect their asset classification and avoid possible surge in non-performing assets. For borrowers, deferment of three-months EMI will temporarily provide relief to them as they will have more cash in hand to fund other emergencies induced by COVID-19 outbreak. Once this ventilator is removed, the situation would be most challenging for banks as well as their borrowers. If current volatile situation on health front triggered by COVID -19 is taken into account, the next six months are going to witness mayhem as more and more people would be struggling to fight the virus. In this backdrop, the revival of economic activities at the moment seems a distant dream.

Will borrowers be able to continue to pay their EMIs once the three months moratorium ends? I am sure the regulator has this question in mind and may be second phase of relief measures is in the offing in June once three months moratorium period ends. Let’s wait and watch. The governments’ ability to arrest the spread of the virus would actually serve as a benchmark for the RBI to decide for how long the banking system can be put on the ventilator.

Now there are certain things which a borrower has to keep in mind. As already mentioned above, the moratorium period on EMIs is not at all a loan waiver. You have to pay these deferred loan installments in future along with interest. Best would be to repay your loan EMIs if your financial position is not constrained. You can even set aside that EMI amount even if you’re not required to pay them during the moratorium unless doing so will adversely impact your financial position. This would ensure speedy lowering of loan burden once the moratorium ends. Most importantly, get complete clarity from your bank how it will impact your loan before taking a decision with regard to availing EMI holiday. Even as the RBI has made it clear that non-payment of loan EMIs during the repayment holiday will not impact your credit score, you should still stay on top of it by checking your credit score regularly.

Precisely, if you can, you must keep meeting your EMI commitments. This, along with the drastic rate reduction can ensure that you prepay your loan ahead of schedule and save on substantial interest outgo in the process. Therefore, use the facility only if you are in financial distress.

Despite all the apprehensions, the RBI policy announcements are bold, decisive, compelling and with a humane touch in attenuating to the needs of the economy to fight through the pandemic. The repo rate cut, the CRR cut, the moratorium on repayments and unconventional liquidity measure of incentivising banks to support CP market are all combined to expect the financial markets to stabilize. Here the main pillar of the success of rate cuts depends upon the speed of transmission of these rates to the borrowers at ground level. We have observed that banks have been very lazy to pass on the benefits of the rate cuts to the borrowers.

(The views are of the author & not the institution he works for)