Decoding the moratorium compound interest waiver

Recently, guidelines were announced for waiving off the compounded interest in the moratorium period on loan EMIs between 01.03.2020 and 31.08.2020. The pandemic put a halt to all economic activities in the country post which things are finally gaining momentum. Much like any other sector, the education sector also dealt with a jolting blow. 

While the larger players came through on their hiring commitments, some simply did not have the luxury to do so. This left graduation batches across streams fishing for employment opportunities and struggling to repay their education loans. Let’s find out the eligibility criterion, the mechanics of it, the anticipated savings and spillover effects.

Who is eligible for this waiver?

The criterion for sanctioning interest loan waiver eligibility as per the announcement goes as per the following conditions:

• Loans eligible under the scheme are select categories ranging from Automobile, Personal, Education, Housing, Consumer Durables to Credit Card dues, MSME, Professional and Consumption loans.
• The loan amount should not exceed ₹2 crore which is an aggregate of all the facilities from the lending institutions.
• The loan account should be a standard account as at 29.02.2020.
• The lending institution for the waiver must be a formal source, either a banking company, co-operative bank, public sector bank or regional rural banks.
• The payment will be made in the borrower's loan account irrespective of the fact whether the borrower has fully availed, partially availed or not availed the moratorium period.
• Under this scheme, the difference between the compound interest and simple interest will be credited in the borrower's loan account for the period between 01.03.2020 and 31.08.2020 and interest rate computation would be worked out as on 29.02.2020.

As per the response of the scheme, the lending institutions will be required to credit the amount in the borrower's account latest by 5.11.2020.

What are the mechanics of interest on interest waiver?

As per academicians and banking experts, in a general sense, the interest portion in EMI will be added to the outstanding principal component of the loan. The new EMI will be ascertained for the remaining portion of the loan. The interest is then calculated with the help of a compounding formula, inferring to pay interest on accrued interest as well. 

However, under the waiver scheme, a borrower has to pay simple interest instead of compound interest on the outstanding loan amount during the moratorium period. As simple interest is lower than the compound interest, it converts to a lower interest burden on the borrower. The difference between the simple interest and compound interest will be borne by the government. 

Who saves more from the scheme?

The mathematical expressions show that borrowers with loans from an older time period will benefit less than those who have just started repaying their loans. This is by virtue of the fact that when the repayment of a loan starts, the proportion of interest part in EMI is high and the principal part is low. Whereas as the loan term is nearer to the end line, the interest part is low and the principal part is higher. 

As per numerical description by MyLoanCare.in, the amount of savings for differing principals is the same as a percentage of the principal for a given time period, as illustrated in the table:

What does it mean for the economy?

The action is anticipated to incur huge budgetary costs and for governments close to ₹7,500 crores, it has the potential to create another crisis in the banking arena. Although the stock market has been in another zone, the benchmark stock indices opened in red following a steep correction seen recently. However, it seems to have since recovered to clock gains.

The financial sector could have lost between ₹4,000 crores to ₹8,000 crores had the Supreme Court disallowed compound interest on loans under moratorium. While the government is bearing some of the losses as of now, there is no free lunch and analysts speculate that it might have spillover effects. 

It’s quite important for students and especially finance enthusiasts to understand the technicalities of this announcement. Check this space out for more news updates!

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