Payment of difference bet compound interest & simple interest in loan accounts: Will you benefit?

Published: October 29, 2020 at 4:53 pm

Last Updated on November 1, 2020 at 6:54 pm

RBI has notified the scheme for grant of ex-gratia payment of the difference between compound interest and simple interest for six months to borrowers in specified loan accounts (01.3.2020 to 31.08.2020). Why was this done? Will you benefit?

About the author: Anjesh Bharatiya is a 30+ taxman by profession and a Chemical Engineer by education. He has been an investor in the stock market since age 15! He likes to write about personal finance, stock markets, government policies, taxation, philosophy and football. Also, by Anjesh: (1) Want to trade in stocks? Here is how your income will be taxed(2) How to use Tax benefits on HRA and home loans (3) How to get tax benefits under a Hindu Undivided Family (HUF).

Update Nov 1st 2020: A simple example of this interest waiver is now available: Examples: Payment of difference bet compound interest & simple interest in loan accounts

After the Coronavirus pandemic struck India, RBI granted loan moratorium on loans in March 2020 for three months which was subsequently extended till 31.08.2020 to help stuck businesses and individual borrowers. Although the loan moratorium didn’t mean that the dues were waived off, it did defer the EMI payments that the borrowers were supposed to make.

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However, the banks’ implementation of the scheme came with the condition that compound interest will continue to be charged on the deferred EMI amounts. This essentially was “interest on interest” and would have meant that the EMIs would become bigger once the moratorium was lifted. Some aggrieved borrowers approached the Supreme Court against charging interest on the deferred loans and the Centre had to come up with a plan which would satisfy the borrowers but at the same time ensuring that the weak Banking sector didn’t suffer another loan waiver body blow. This scheme comes as a partial relief to the borrowers and would be wholly Government funded. This means that there would be no additional burden on the already capital-starved banks. If the entire interest had been waived off on the moratorium loans for the moratorium period as some petitioners wanted, the banking sector would have taken a huge hit of up to Rs 2 lakh crore which would have jeopardized the entire financial sector. The current scheme will only cost the Government approx Rs. 7500 crore in comparison.

Details of the scheme: As noted, this scheme essentially means the difference between compound interest and simple interest for the period 01.03.2020 to 31.08.2020 will be refunded to the borrowers. Some major features of the scheme are:

  • The banks will calculate the difference based on the rate of interest applicable as on 29.02.2020.
  • The difference will be paid directly to the borrower in his account by his respective lending institution before 05.11.2020.
  • Further, the scheme will apply to all eligible borrowers even if they didn’t avail the moratorium. Therefore, if you have made prompt repayments even during the moratorium period, your loan outstanding on 01.03.2020 will be the basis for the calculation of the ex-gratia payment.
  • The eligibility conditions for the scheme include all outstanding personal loans, housing loans, education loans, auto loans, credit card dues, MSME loans, consumption loans, and loans for the purchase of white goods taken from all banks, housing finance companies, microfinance companies (MFIs) and Non-Banking Financial Companies (NBFCs) of the outstanding amount or sanctioned limit of up to Rs 2 crore provided the loan was not classified NPA as on 29.02.2020.
  • For loans outstanding on 01.03.2020 but closed before 31.08.2020, the payment will be made for the period till the account closure date.
  • Only term loans are eligible, and Cash Credit limits & Overdrafts are not covered under the scheme except for MSME loans where Cash Credit limits & Overdrafts are also covered.
  • State Bank of India (SBI) has been mandated to receive claims from lending institutions for the payments made and reimburse the amount to them.
  • Each lending institution will also put in place a grievance redressal mechanism for borrowers eligible for the scheme.

Bottom line: Through this scheme, the Government has come up with a neat plan to help the stranded borrowers while also safeguarding the banking system. The scheme will also not unnecessarily burden the already stretched Government finances. By covering borrowers who didn’t avail the moratorium, the scheme also ensures that the credit culture is not spoiled as was the case with past agriculture loan waiver schemes where the borrowers making prompt repayments were given short shrift. On the whole, this scheme is the best possible outcome in the present circumstances which has something to offer for all small borrowers.

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