On November 17, the Central Government imposed restrictions on the withdrawal of funds from the Lakshmi Vilas Bank (LVB) till December 16, (except for a maximum Rs 25,000 per account as relief to small depositors) on the advice of the Reserve Bank of India (RBI). Plus, the LVB’s Committee of Directors was superseded. The RBI invited suggestions and objections “within three days” on a draft scheme of amalgamation of LVB with DBS Bank India. On November 25, the Central Government approved the scheme proposed by the RBI. The LVB-DBS merger came into force on November 27 and the moratorium imposed on withdrawals was lifted. Foreign banks may operate in India either by having their branches in the country directly owned/operated by them or by creating a wholly-owned subsidiary (WOS) registered here. The Singapore-based DBS Group Holdings Limited has been operating in branch mode since 1994 but switched to WOS model in March 2019.

All the assets and liabilities of LVB now stand transferred to DBS India. By June, DBS India had a sizeable customer deposit base of Rs 24,700 crore, including Rs 5,700 crore as low-cost deposits. It is now busy rebranding LVB branches and ATMs with its logo. The parent foreign bank is expected to bring an additional investment of Rs 2,500 crore. DBS India, with just over 30 branches in the country (most of its business is in the branchless mode) now gets ownership of the LVB’s fixed assets (historical, depreciated cost of Rs 463 crore on March 31, mainly comprising 560 branches and 970 ATMs); cash and investments with the RBI (Rs 1,048 crore on March 31) and other investments (Rs 5,384 crore on March 31). The LVB gets access to deposits of Rs 21,443 crore, including about Rs 6,000 crore low-cost CASA (current and savings accounts) deposits. On the flip side, DBS has to service LVB’s borrowings (Rs 756 crore on March 31). Out of the total advances (Rs 13,828 crore outstanding on March 31), about one-fourth were Non Performing Assets (NPAs). The gross NPA ratio had deteriorated from 15.3 per cent on March 31, 2019 to 25.39 per cent on March 31 this year and remained high at 24.45 per cent on September 30.

While the LVB’s 20 lakh depositors and 4,000 employees can heave a sigh of relief, its over 97,000 investors have been hit hard. Forced mergers of banks are nothing new but in an unprecedented action in the LVB’s case, the shareholders have been divested of their equity shareholding, reserves and surpluses. Since the value of equity shares is officially decreed to be zero, the erstwhile owners of the LVB will not get any share in the LVB+DBS banking entity. Also hurt are bondholders as all of LVB’s  Basel-III compliant Tier-2 bonds worth Rs 318 crore were written down. Bond-holders will not get back their invested money, nor interest on them. Significantly, srapping Tier-2 bonds is an unprecedented action. The move was thus both, swift and uncommon, but the problem had been brewing for some time. The LVB had been incurring losses for the past 10 quarters and the RBI initiated Prompt Corrective Action (PCA) in September 2019, which asked the bank to bring in additional capital, restrict further lending to corporates, reduce NPAs and improve the Provision Coverage Ratio to 70 per cent.

These actions/decisions of the Central Government and the RBI have been challenged by the LVB’s shareholders in Mumbai and Madras High Courts (HCs). The Mumbai HC declined to stay the amalgamation but kept the plea filed before it for monetary compensation pending. The Madras HC, too, declined to stay the amalgamation but passed some interim orders giving some relief to the LVB’s shareholders on a petition filed by AUM Capital Market Private Limited, a retail investor holding shares in LVB.

Shareholders contend that they have been deprived of the LVB’s ownership without any monetary compensation. This amounts to unjust enrichment of a foreign bank. The manner of selection of DBS India as the transferee company has also been questioned. What has frustrated the LVB shareholders is the fact that the same DBS that has now acquired the bank with zero compensation to shareholders had offered to buy 50 per cent of the LVB’s shares for at least Rs 100 per share in 2018. Since then, the LVB’s value deterioration has been fast. The share price of the LVB lost 58 per cent this year and went to less than Rs 10 a share. The LVB’s total business shrank from Rs 47,115 crore at the end of September 2019 to Rs 37,595 crore at the end of September this year.

By then, the LVB’s Tier-1 Capital Ratio and overall Capital Adequacy Ratio (CAR) as per Basel-III norms had turned negative. With a large gross NPA ratio of 24.45 per cent, the LVB had a negative net worth of Rs 699 crore. Therefore, scrapping the shares and Tier-2 bonds of the LVB means that the bank has been practically wound up, with core investors asked to bear the accumulated losses. And the junked entity has been handed over to a white knight investor to take over in the interest of the LVB’s 20 lakh depositors. Aggrieved shareholders contend that even if the authorities have the power to reduce the share value during an amalgamation, reducing share value to zero cannot be done without very compelling reasons. And these reasons (if any) have not been disclosed.

Instances of commercial banks failing are rare. As the Government and the RBI are empowered to order consolidation, compulsory amalgamation and liquidation of small banks, no commercial bank has failed. Forced mergers of weak banks with stronger ones are a normal practice to safeguard depositors’ interest.

The LVB is one of the oldest private banks. It was founded in 1926 with a fairly distributed ownership. At the end of March 2012, the LVB had 12.92 per cent non-resident shareholding, which increased to 43.1 per cent by March 2019. During the period, resident individual shareholding came down from 56.73 per cent to 27.7 per cent. Resident financial institutions increased their stake from 8.47 per cent to 20.9 per cent.

The 20.9 per cent Indian Financial Institutions and 38.4 per cent foreign companies, together commanding majority control of the LVB, failed to exercise due diligence and control the management even as the bank’s lending portfolio became problematic. The LVB is a banking company registered under the Companies Act, 1956. Banking companies are governed differently from other companies in India. They are regulated by both the Companies Act and the Banking Regulation Act, 1949. And the Banking Regulation Act, being a specialised law, takes precedence over the conflicting provisions of  the Companies Act. Section 45 of the Banking Regulation Act, 1949 empowers the RBI to apply to the Central Government “for suspension of business by a banking company and to prepare a scheme of reconstitution of amalgamation.” So the triggers, processes, control mechanism and so on for mergers and acquisitions are different than those for non-banking companies.

Just like the Companies Act, the Insolvency and Bankruptcy Code applies to banking companies, too, but the Banking Regulation Act prevails over the other two Acts. The one month “moratorium” imposed on the LVB on November 17 was akin to anaesthesia that is given before a surgery. Keeping the LVB under a moratorium for too long would have affected 20 lakh depositors. The RBI had to find an able and willing investor ready to take over. For the last two years, the LVB and its promoters have been trying to lure investors to infuse additional capital to meet regulatory norms.

For the takeover of financially-distressed non-banking companies, resolution professionals are appointed by the National Company Law Tribunal (NCLT). This invites tenders from potential investors and the company is handed over to the highest bidder. In the case of  weak banks that are in need of rescue, there is no such practice of inviting tenders. The transferee banking company is selected based on the professional judgment of the RBI. Whether the selection of DBS India was based on rational considerations and whether the LVB’s pre-amalgamation valuation justified shareholders/bondholders being denied any monetary compensation are now sub-judice. Judicial review of regulatory wisdom is not unprecedented.

 (The writer is former Special Secretary, Ministry of Commerce and Industry)

Although capital is a scarce resource for any business, it is even more scant for small and medium enterprises (SMEs). Therefore, cash flow and working capital management are the most crucial challenges of organisations in general and SMEs in particular. Working capital is short-term in nature and refers to the funds required for the daily functioning of a firm. In business parlance it consists of accounts receivables (debtors and any pre-payments, stock or inventory) and accounts payable (creditors and short-term provisions). The lifeline of any enterprise is the flow of cash and other liquid assets through a business cycle — a journey of collecting receivables from the debtors to pay off the creditors. This is also known as the cash conversion cycle. The efficiency and, therefore, the success of a business depends upon how fast the goods are converted into cash.

SMEs differ in many ways from large firms in terms of their financial behaviour and decision-making, mainly because of their characteristics and ownership. This ultimately reflects in their financial habits. So, what are the factors that affect the availability of capital to small enterprises? One of the most important issues is the size. According to researchers, during the start-up phase, the owner’s personal savings are an important source of funds. Young and small firms do not have an established track record and may be characterised by informational opacity, making banks and other financial institutions reluctant to lend to them. In general, firms which are less than four years old, rely more on informal sources of funding.

However, when the SMEs increase in size and become larger, they have a greater network of banks willing to fund their business. The firm’s ability to deal with multiple banks and other credit agencies generally grows with size, too. So, they rely more on long-term debt and external financing, including bank loans.

Second, the type of ownership is another important determinant for the source of funding. Any SME with a concentrated ownership, like in a proprietorship, should be more prepared to use bootstrap financing, as it would have greater difficulty in accessing a formal source of credit. From the lender’s perspective, in such SMEs, there is no clear distinction between the owner and the firm, information asymmetry is prevalent and an ability to provide collateral is missing. On the other hand, a private limited SME may be viewed by financing agencies as more structured and credible. As a result, formal financing options are freely available to it. Third, the location of the start-up makes a huge impact. A firm’s proximity to the banks has an influence on its ability to gain external funding. Research also suggests that one of the reasons for a company’s failure is poor location that prevents customers and suppliers from reaching it. Therefore, despite high rentals, SMEs prefer to move to urban areas for the sake of better infrastructure and the ease of raising external finance.

Fourth, several researchers have provided evidence that the sector where the SME is operating has an impact on the short and long-term debt available to it. For example, short-term credit is used more in wholesale and retail trade as compared to manufacturing SMEs. Whereas the construction sector, hotel, hospitality and mining industries appear to depend more on long-term finance. And finally, availability of assets plays an important role in raising funds. From a lender’s point of view, collateral, which is also known as the lender’s second line of defence, is highly relevant while approving loans. Researchers Ono and Uesugi studied the Japanese SME loan market and found a positive relationship between the use of collateral and the ease of access to bank loans and external financing. It can also be understood that firms with lower tangible assets would face difficulties in accessing funds.

Additionally, the characteristics and gender of the owner too influence a firm’s capability to raise external funding. According to several researchers in different countries, men and women differ in the way they raise cash for their businesses. There is empirical evidence that women entrepreneurs start their business with a smaller start-up capital, in fact less than half of the amount used by men. In addition, women also face discrimination from banks and other financial institutions. This is evident from the higher rates of interest charged from women entrepreneurs, the requirement of additional collateral, higher loan denial rate and so on. The age of the owner, too, impacts the personal financing preference. Older SME owners are less likely to take additional finance into their firms. Younger owners tend to use a variety of external cash sources like loans, overdrafts, credit cards and personal savings.

SMEs are the backbone of any growing economy. Therefore, it is crucial to understand their financial behaviour and practices which are very different from the financial management of large corporations. This would help policymakers come up with ways to improve the external financing scenario for such firms, as stronger SMEs make a stronger economy.

(The writer is Associate Professor, Amity University, Noida)

While Raghuram Rajan often sounds like he is yet to come to terms with his effective removal from the Governorship of the Reserve Bank of India (RBI), he and his successor Viral Acharya do have a point when they panned the idea mooted by the central bank to allow the corporate sector to enter banking. In a piece, they argued that this would be devastating and would lead to “connected banking” and it isn’t hard to see their point of view. We have seen what happens with “connected banking” and the dramatic collapse of Yes Bank and the more recent rescue of Laxmi Vilas Bank by the RBI are cases in point. As Rajan and Acharya asked, “How can a bank make good loans when it is owned by the borrower?”

The central bank would be stupid to ignore the advice of their own former honchos as well as India’s top legal eagles that were consulted on this. India has had far too many banking disasters in the recent past for another one to be made through bad policy making. Even if the RBI promises to continue through regulatory oversight, the scandals involving Vijay Mallya and Nirav Modi highlight that promoters can bend the rules and cover their tracks (for a while at least) if they want to. Even if corporate-owned banks are prevented from giving loans to non-financial entities of the corporate, what will stop them from giving loans to relatives of bureaucrats and politicians in order to curry favour? Even in the best-run banks, allegations of underhand dealings and impropriety exist as we are learning in the case of ICICI Bank and their disgraced former chief executive against whom there are damning allegations. Instead, it would be more prudent for the RBI and the Ministry of Finance to explore possibilities of privatising India’s burdensome public-sector banks. Are the rule changes being made to assist one or two particular corporate groups in India and make them even stronger? Until the RBI and the government cannot answer this one question, one will assume it to be true. Ergo, this bad idea should be dispensed with forthwith. As for private lenders failing, just remember the lasting impact of the IL&FS fiasco.

Issuing of post-dated cheques or signing of irrevocable mandates to banks to debit the agreed  Equated Monthly Installment (EMI) on a fixed date every month is a common practice when loans or goods purchased on credit are repaid on a regular basis. If the cheque or automatic electronic debit is dishonoured by the bank for want of funds/mandate and the debtor fails to clear the dues within 15 days of a written notice by the bank (to be given within 30 days of dishonour), the creditor can file a criminal complaint. This is because  the debtor commits an offence punishable with up to two years in jail or fine up to two times the amount of the cheque issued or both. The criminal case can be dropped in case of a compromise or settlement. This is provided under Section 138 of the Negotiable Instruments Act, 1881. The objective of all this is to promote the efficiency of banking operations and to ensure credibility in transacting business through cheques. The 1881 Act was amended in 1989 to introduce a one-year jail term that was enhanced to two years in 2003. But the offence was made “compoundable”, meaning that the criminal proceedings can now be dropped if some compromise is reached between the two parties.

India, with its huge population, has problems that are unique to it and the overburdening of resources or institutions is one of them. So, it is not surprising then, that a total of 346 lakh court cases were pending in the country on October 29 this year. Out of this, there were over 251 lakh criminal and over 95 lakh civil cases, of which over 199 lakh criminal cases were more than a year old.  A Public Interest Litigation (PIL) filed by the Indian Banks’ Association (IBA) in 2013 had highlighted that out of the pending 270 lakh court cases, about 40 lakh were cheque bounce cases, involving about Rs 1,200 crore. These cases, estimated to be about 20 per cent of the total caseload (2018), are clogging the already overburdened criminal courts. Do we have enough jails and judges to convict every offender? Shouldn’t we have a hierarchy or priority list of offences to be targetted by the prosecution and adjudicating systems? Should the debtors, who have already mortgaged movable and immovable properties, be further subjected to criminal liability?

The Government is considering decriminalising cheque bounce cases and some other “civil wrongs.”  On June 8, the Finance Ministry sought stakeholder comments on its proposal to decriminalise 39 “minor economic offences” created under 19 Acts, including non-repayment of loans and dishonour of a cheque or automatic electronic debit for “improving the ease of doing business and helping unclog the court system and prisons.” However, the decriminalisation proposal has been opposed by the IBA, the Confederation of All-India Traders, the Finance Industry Development Council, the Federation of Industrial and Commercial Organisation and some Bar Councils.

The Bar Council of Delhi has highlighted the effect of the pandemic on lawyers in the country and how every advocate is facing a financial crisis.  The Bar Councils of Maharashtra and Goa, too, have opposed the proposal to decriminalise Section 138 of the Negotiable Instruments Act. They contended that the offence of cheque bounce should not be termed as a “minor” infraction by the Government in its bid to decriminalise the same. For lawyers, decriminalisation clearly means an adverse impact on their livelihoods. For traders selling on credit, there is a genuine problem of having no security against customer default. Instalment purchase of goods on EMI is supported by post-dated cheques, and no one will accept cheques if their bouncing is decriminalised. Trade will be left at the mercy of civil litigation that takes several years for justice to be delivered. Even after the current stringent Section 138, more than 20 per cent of all pendency of cases across the country is only pertaining to cheque bounce.

The bankers’ opposition to decriminalisation can also be understood for cheque bounce against unsecured loans. However, there is absolutely no justification for continuing with this additional protection in case of secured loans. While sanctioning EMI-based loans, banks insist on mortgage of immovable property or shares, debentures, fixed deposits and so on. Or they obtain guarantees from employers for deduction from the borrowers’ salary. In such cases, cheque bounce should be considered for decriminalisation to begin with. Borrowers — distressed by the Coronavirus pandemic — have been provided some relief by way of moratorium and deferral of fresh applications for insolvency proceedings but the criminal liability under the Negotiable Instruments Act, 1881, as amended in 1989, 2003 and 2018, remains. Normally, for criminal liability to be pinned to a person, presence of mens rea, malafide intention is a must. However, in cheque bounce cases, malafide intention may or may not be there and need not be proved. A strict liability has been created without going into a cheque issuer’s intentions as a measure to build trust and credibility in cheque transactions.

The objective of amending Section 138 of the Negotiable Instruments Act in 1989 was to add credibility in transacting business through cheques. Current realities are so very different from 1989 when cheque bounce was first criminalised.

Provision of criminal liability — prosecution and imprisonment — on strict liability basis, without the need to prove malafide intention, is an identified deterrent for attracting new investment. It is in larger public interest to declog our criminal courts and jails.

In Kaushalya Devi Massand vs Roopkishore Khore case, the Supreme Court held that the offence committed under Section 138 of the Negotiable Instruments  Act cloaks a civil wrong as a criminal act and the gravity of offence under Section 138 of the Act cannot be equated with a crime under the provisions of the Indian Penal Code or other criminal offences.

In Makwana Mangaldas Tulsidas vs. State of Gujarat and others case, the Supreme Court recently favoured decriminalisation of dishonour of small value cheques. The court suggested various ways to deal with the situation of overflowing cheque bounce cases pending adjudication across the country. The apex court suggested developing a mechanism for pre-litigation settlement in these cases.

The Centre, while decriminalising some defaults, has to balance the interests of lawyers, the business community and the welfare of the public at large, especially those who are not wilful defaulters. In cheque bounce cases, we need to find a balance so that malafide intent is punished while other, less serious offences are compounded. As the working of the SARFESAI Act (The Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act) and the Insolvency and Bankruptcy Code (IBC) have shown, the cases of wilful defaults are very few and such offenders continue to dodge the law while a large number of non-wilful defaulters continue to suffer harassment in courts. Public policy is all about balancing conflicting requirements and expectations. Creditors would want to have as many solutions as possible and pursue all those remedies simultaneously. However, such an approach has a deleterious effect on business sentiment. It may end up having a chilling effect on potential borrowers and consumer demand. If fear of imprisonment and litigation charges along with a fine truly had a deterrent effect and resulted in  timely payment of cheques, the courts would not have such a big pending caseload. And it is this huge backlog of cheque bounce cases that delays the trial of more serious crimes and at the same time erodes public faith in the judicial system.

Hence, decriminalisation of bounced cheques should be seriously pursued. Secured creditors have remedies available under the Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest Act, 2002 and the IBC, 2016. Cases involving secured lenders should be decriminalised except for borrowers declared “wilful defaulters” or “fugitive economic offenders.” Even in cases involving unsecured creditors, the criminal cases should be continued against repeat offenders and a more lenient view may be taken of first-time defaults and offenders. There should be very clear articulation of legislative intent as to its retrospective or prospective operation. To eliminate a large pendency of court cases, retrospective application based on a differentiating criterion like secured/unsecured creditor and wilful/non-wilful defaulters would be necessary and desirable.

(The writer is former Special Secretary, Ministry of Commerce and Industry)

The Finance Ministry is building pressure on the 15th Finance Commission (15th FC) to allow greater flexibility while fixing the fiscal deficit (FD). It wants to adopt a flexible, range-bound FD target instead of a fixed number. With this aim in mind, the Modi Government is reviewing the Fiscal Responsibility and Budget Management (FRBM) Act. The issue was discussed at the Economic Advisory Council (EAC) of the 15th FC, wherein the chairman, NK Singh, cited a similar practice followed by the Reserve Bank of India’s (RBI) with +/- two per cent inflation target while deciding its monetary policy. The immediate prompt for this is the sharp contraction in the Gross Domestic Product (GDP) by about 24 per cent in the first quarter of the current financial year (FY) and a corresponding steep reduction in tax collections even as the expenditure commitments are on the upswing (courtesy the two stimuli already given). As a result, on May 8, the Government raised its gross market borrowing target for the FY 2020-21 to Rs 12,00,000 crore, up from the Rs 7,80,000 crore provided for in the Budget on February 1.

  Of this, the Government had already borrowed Rs 7,66,000 crore during the first half of the current FY and plans to borrow the remaining Rs 4,34,000 crore by January 2021. At Rs 12,00,000 crore, the borrowing limit is already set at about 5.8 per cent of the GDP — 2.3 per cent higher than the budgeted FD target of 3.5 per cent. With this and demand for yet another Stimulus III gaining ground, it is not surprising that the Finance Ministry is building pressure on the 15th FC. During the current year, we have an extraordinary situation, so one can understand the desperation. But it is important to recall here that in his budget speech for 2016-17, the then Finance Minister Arun Jaitley had announced the Government’s intent to review the FRBM Act (2003) with a view to make the target flexible (that the announcement was made following the year 2015-16, when it had achieved the FD target of 3.9 per cent, sounds a bit anomalous). He had set up  a committee under NK Singh (it included among others, the then Chief Economic Adviser, Arvind Subramanian, and the then Deputy Governor, RBI, Urjit Patel) to examine the issue.

The committee recommended a “glide path” for the next six years, beginning 2017-18. It recommended a FD target of 2.5 per cent, revenue deficit 0.8 per cent, combined Centre-State debt ceiling of 60 per cent and a Central debt ceiling of 40 per cent for 2022-23. Further, it fixed three per cent FD to be achieved during 2018-19. It also allowed the Government to breach the target — by up to 0.5 per cent — in case of “far-reaching structural reforms with unanticipated fiscal implications.”

In the amendment to the FRBM Act vide Finance Bill 2018-19, even while retaining the “escape clause” to cover unanticipated events, the Government adopted the glide path of achieving three per cent FD by 2020-21 instead of 2018-19 mooted by the committee. Further, it set the debt limit of 40 per cent for the Centre to be reached by 2024-25 instead of the committee’s mandate of 2022-23.

This cherry-picking may be seen in the backdrop of the Government missing the FD target for 2017-18 by 0.3 per cent and seeing no hope of achieving three per cent during 2018-19 as recommended by the committee. While presenting Budget 2020-21, Sitharaman has already invoked the escape clause of the FRBM Act to relax the FD targets for FY 2019-20 from 3.3 per cent Budget Estimate (BE) to 3.8 per cent in the Revised Estimate (RE) and for FY 2020-21, from three per cent as per the glide path required under the Act to 3.5 per cent. The one big thing that she did last year was reducing the Corporate Tax rate, which meant a revenue loss of close to Rs 1,50,000 crore annually. The reform was far-reaching and structural but one wonders whether this was an event not anticipated by the Government.      

Ironically, the above numbers do not give the true picture of the FD as a lot of expenses, despite being a liability of the sovereign Government, are kept off its balance sheet. These are deferred subsidy payments (DSPs) and extra-budgetary resources (EBRs), a nickname for borrowings by Public Sector Undertakings (PSUs) and other agencies of the Government on its behalf. Including these off-balance sheet items, the FD for 2017-18 and 2018-19 would be about 5.9 per cent and 5.7 per cent respectively. For 2019-20, including DSPs alone, FD would be 5.1 per cent. Add EBRs and the deficit will gallop. For 2020-21, the likely deficit of 5.8 per cent is exclusive of DSPs and EBRs.

There is a short provision in the Budget: Food subsidy about Rs 1,03,000 crore and fertiliser subsidy around Rs 80,000 crore. Plus, there will be a huge shortfall in proceeds from disinvestment by at least Rs 1,50,000 crore as big ticket sales such as Bharat Petroleum Corporation Limited (BPCL) and Life Insurance Corporation (LIC) are unlikely to go through during the current year. This adds up to two per cent, taking the total to 7.8 per cent. Including EBRs, the FD could touch 10 per cent.  Already, under the existing dispensation of FD being a fixed number, the Government has a lot of leeway — explicit as well as not so explicit. On the explicit side, we have seen the fiscal consolidation glide path made fairly liberal to suit the budget math as also the revised FD being significantly higher than the target — yet going unpunished (for instance, during 2008-09, the actual FD was six per cent against the target of three per cent as per the FRBM Act, 2003). On the not so explicit side, DSPs and EBRs have been used to camouflage the true deficit.        

If the FD range gets embedded in the FRBM Act, this will amount to giving legal sanction to slippages. It will defeat the very purpose of fixing a target which is to obligate the Government to keep the excess of its expenses over revenue within a specified limit. The moment the law itself prescribes a range, say of three per cent-3.5 per cent, even the most discerning Government will take the higher end of the range as the benchmark as from a legal standpoint, violation will happen only when the actual exceeds 3.5 per cent.

To put it differently, providing for a range is a more subtle and sophisticated way of embedding in the legislation a more relaxed target without catching the attention of the not so discerning eye.     

The comparison with inflation targeting under the monetary policy to justify FDI range is not all fours. While, the FD target has a direct bearing on budgeting by the Centre (a swing of 0.1 per cent either way makes a difference of Rs 20,000 crore in its borrowing limit), inflation targeting by the RBI does not impact the finances of banks. For a proper comparison, we need to look at the RBI mandated “provisioning” for a loan that becomes an NPA. That is a fixed number, say 25 per cent (for an account remaining unpaid for up to one year), not a range.              

It is argued that a range brings an element of predictability in knowing how far the Government can go in expanding its borrowing programme and the resultant impact on crucial parameters like bond yields, interest rate; hence helpful in boosting investor confidence. This is a frivolous argument. Whether it is one fixed number or a range, there is predictability in both the scenarios. The difference is notional as in a range, one looks at the upper end. Unpredictability arises when things such as DSPs/EBRs are done outside the FRBM framework; sadly, those are swept under the carpet.  

Another argument in support of range is what some experts describe as reinforcing “counter-cyclical” objectives. Put simply, when the economy is on a downswing, then the Government needs to undertake major investment to rein in the slide and put the economy back on the growth trajectory. It is primarily to tackle extraordinary situations such as during the current year that a 0.5 per cent cushion is permitted as per the 2018-19 amendment to the FRBM Act.     

The incorporation of FD range does not offer anything better than what is already there in the FRBM law, i.e. fixed number FD target plus escape clause, unless it is the intent of mandarins in the Finance Ministry to have both, namely range as well as the escape clause. That would be disingenuous. The 15th FC should refrain from going for a range-bound FD. The extant arrangement should continue with suitable increase in the permissible breach under the escape clause. All hidden slippages such as DSPs and EBRs should be prohibited.

(The writer is a policy analyst)

On March 27 the Reserve Bank of India (RBI) Governor, Shaktikanta Das, announced a comprehensive action plan to resuscitate the economy devastated by the Coronavirus. Apart from measures to increase availability of credit and reduction in the cost of capital, the plan sought to ease the stress of loan repayments on businesses and individuals. Among others, this included a three-month moratorium on payment of instalments in respect of all term loans outstanding on March 31. On May 22, Das announced extension of the moratorium for three months till August 31. To ease the burden of payment on those who availed of working capital facilities, the Governor allowed them to convert accumulated interest for the deferment period into a funded interest term loan (FITL) which can be paid by March 31, 2021.  

The RBI eased asset classification norms for all accounts coming under moratorium, too. These accounts will be treated as non-performing assets (NPA) from 270 days overdue instead of 90 days overdue as per extant rule. It has also extended the 210-day resolution period for all large stressed accounts under its June 7, 2019 circular (on its expiry, if banks are not ready with a resolution plan, the Insolvency and Bankruptcy Code [IBC]comes into play) by a further 180 days. To address the situation after the moratorium ends, on August 6, the RBI announced a scheme for one-time restructuring of the debt for large companies, besides extending till March 31, an existing restructuring scheme for micro, small and medium enterprises (MSME) with relaxed norms. It also set up an expert committee under KV Kamath to recommend the required financial parameters, along with the sector-specific benchmarks for this special window.

 Meanwhile, one Gajendra Sharma had filed a Public Interest Litigation (PIL) in the Supreme Court (SC) demanding waiver on interest charged by a private bank, citing relief given by the RBI on payment of Equated Monthly Installments (EMIs) during March and August 31, due to the pandemic. During the last three months or so, the SC has heard the matter thrice. It has made the following observations: On June 4 it said, “On one hand, you are granting moratorium (on loans) but continuing with interest. It is more detrimental.” On June 17 it observed, “There is no merit in burdening customers, who have opted for the RBI-approved loan moratorium, with additional interest. Once you fix a moratorium it should serve the purpose desired. We see no merit in charging interest on interest.”

On September 10, 2020, it said, “We are keen to waive interest on interest” for borrowers who availed the moratorium and asked the Government and the RBI to come up with a “concrete plan” with regard to the vexed issue. It posted the matter for hearing on September 28, when it is likely to give its final order.

From the above, it is abundantly clear that the SC does not want banks to charge interest on interest for the moratorium period. Whether or not this will get reflected in its order, one can only wait and watch. Meanwhile, it may be worthwhile to look at the desirability or otherwise of such a move in particular, its impact on the viability and financial stability of the banking system. 

At the outset, by granting moratorium to all and sundry, the RBI gave a signal that almost everyone would be devastated by the pandemic.

The SC has gone a step further by aligning itself with a plea that the banks should also not be charging “interest on unpaid interest amount during the moratorium period.” Such a sweeping and broad-based generalisation is totally divorced from the reality. No doubt, the Coronavirus has caused unprecedented damage but this can’t be pushed to a point of arguing that almost everyone has been incapacitated and hence unable to service the loans. After all, even during the lockdown, a number of activities, especially health related, all essential goods and services besides firms in several other sectors permitting work from home (WFH) continued their business. Look at the Gross Domestic Product (GDP). During April-June 2020 it was about 23 per cent less than during April-June 2019 but it was not reduced to zero.

Businesses which contributed to this GDP (about Rs 2,550,000 crore during April-June 2020) can’t be termed as not being in a position to service their loan. The proof of the pudding is in the eating. A large number of borrowers have not availed of the moratorium. For instance, in case of the State Bank of India (SBI), over 80 per cent of its retail borrowers did not avail of the moratorium for two out of the first three months (March-May) initially allowed by the RBI. Further, 90 per cent of such borrowers did not avail of the moratorium for one month. In other words, they continued to pay their EMI. 

Yet, if in retrospect, the SC allows waiver of “interest on unpaid interest amount” for all and sundry, this will be unfair to and discriminate against such borrowers who decided not to avail of the moratorium and continued to service their loans. A business by nature has ups and downs. Every enterprise has a phase of buoyancy when it gets to reap extraordinary profit (for instance, in the automobile sector during 2017-18/2018-19). Why can’t the surplus or savings from those years be used as a buffer against the current setback? Alternatively, in future, say during 2022-23, when the pandemic impact will subside and the sectors start generating good profits, the surplus to be retained therefrom will provide adequate cushion to pay for current liabilities (including interest on interest).

The point in short is that there is no compelling need for a firm impacted by the crisis to rush to banks for relief. To enjoy the fruits when the going is good and come to the bank or Government for bail-out when in crisis is totally unacceptable. A bank does not run a charity. Its business model involves taking money from depositors in lieu of promising a fixed return (call it interest rate) which is added to the invested amount and returned to the depositor on maturity. The bank lends the funds thus collected to borrowers, viz. industries, businesses or individuals and so on and uses the interest earning to service its depositors (besides paying for its own “intermediation” expenses).

The bank is legally bound to honour its contractual obligation to the depositor i.e. it must return to him/her the principal amount plus accrued interest on the maturity/due date. Imagine a situation wherein a bank defers payment of the interest portion say by six months (because it is under stress for that long). Then it will necessarily have to pay “interest on the unpaid interest amount.”

The depositor won’t forego this just because the bank was under stress. This logic holds with equal force when it comes to the borrower discharging his/her liabilities to the bank. If the former delays payment of interest (courtesy, moratorium mandated by RBI) then it must pay “interest on unpaid interest amount” to the latter. Yet, if the top court forces banks to forego it, this will dent their ability to service the depositors. It will strike at the root of architecture of the financial system and pose a serious threat to the viability of bank.

Businesses can always approach banks for support by way of additional funding and negotiate for changes in the terms of payment. This is precisely what the RBI is facilitating by way of one-time restructuring scheme (as 26 sectors have been identified by the Kamath Committee for a customised package). But to expect banks to bear a portion of the cost in a broadside and high-handed manner is an abhorrent idea.

On the other hand, to expect the Government to pick up the cost tag would also be illogical and unfair. Apart from Covid-related expenses on medical facilities and health infrastructure (besides increasing expenditure on defence in the current security environment), the Union’s scarce resources need to be preserved only for addressing basic needs of the poor whose survival depends on daily wages and who — unlike firms — had neither any savings from the past nor any hope of having any windfall gain in the future.   

To conclude, if SC orders what it has alluded to, this will affect the viability of banks or further bloat fiscal deficit (in case, the Government foots the bill), thereby jeopardising the country’s macro-economic fundamentals. This should be avoided and businesses need to remain focussed on making best use of the RBI’s package. Even so, the most crucial requirement at this juncture is to “flatten” the Covid curve at the fastest pace so that economic activities get back to normal. Sans this, any relief, howsoever generous, won’t be of much help.

(The writer is a New Delhi-based policy analyst)