Do you know the impact of deferring your EMI?

In order to mitigate the risk of economic recession, RBI on the 27th of March’20 announced some relief measures for easing the financial crisis looming over the country. In our today’s article, we will try to decode these announcements in a layman language. We will be as elaborative as we can for our readers. So here we go…

On 27th March, in response to the ongoing demand from various industries and trade associations, India’s central bank; Reserve bank of India announced few measures to provide relief to the already stressed financial condition of the country.

Before we deep dive into what it means for us, let us first understand a few concepts here. The main objective of RBI is to control Inflation and ensure the growth of our economy, particularly GDP. To do this, RBI controls the supply of money in the economy i.e. how much money should be available for the industry or the economy as well as the cost of it. To implement this, they have come up with certain monetary policies, which comes as a handy tool for the entire banking system. Let us see one by one, how it makes use of the same.

Disclaimer:  This may get a little technical for a naïve in finance. If you are someone who is just looking for the only the impact of the RBIs announcement can skip this part.

Cash Reserve Ratio (CRR): It is the ratio of the entire deposits a bank has through its Savings account and Fixed deposits. Currently, CRR is 3% (reduced by 100 bps from 4%) which means Banks have to keep this portion in cash with the RBI which will not fetch any interest or profits. Hence, the bank cannot lend this amount to anyone.

Statutory Liability Ratio (SLR): It is that portion of the total deposits that the bank collects through fixed deposits and savings bank deposits, which banks are required to invest in interest-bearing instruments in the form of liquid assets such as gold, treasury bills or RBI approved securities such as government securities. Current SLR is 18.5%

Repo Rate: When we need money, we take loans from banks. And banks charge a certain interest rate on these loans. This is called a cost of credit (the rate at which we borrow the money). Similarly, when banks need money they approach RBI. The rate at which banks borrow money from the RBI by selling their surplus government securities to RBI is known as “Repo Rate.” Repo rate is the short form of Repurchase Rate. Generally, these loans are for short durations up to 2 weeks. Currently, it is 4.4 % (down from 5.15%)

Reverse Repo Rate: Reverse repo rate is the rate of interest offered by RBI when banks deposit their surplus funds with the RBI. When banks have surplus funds but have no lending (or) investment options, they deposit such funds with RBI. Banks earn interest on such funds. Currently, it is 4%

For someone who skipped the above section can now start reading from here J

Using these tools, RBI EITHER infuse more money in the market when they see a slump in the economy (by reducing CRR and SLR, banks has more money at hand to lend) to boost consumption and therefore GDP OR suck the excess liquidity (by increasing CRR and SLR, banks has limited funds to lend) to contain the demand if too much demand is causing inflation.

However, during the current Covid-19 crises, the scenario is a bit different. There is absolutely no production of goods or services in the entire country. Businesses are striving hard to meet their obligations be it Rent, Salary, EMIs, and other fixed costs. Without sales, there is absolutely zero realization. Hence there is no generation of income, especially for business owners. Therefore, RBI stepped in and permitted banks, financial institutions to allow a moratorium of 3 months for all EMIs or interest falling due between 1st March to 31st May’20.

Now let us understand the fine prints and underlying meaning of this moratorium scheme announced by RBI:

Firstly, RBI has permitted all institution whether it is Commercial banks (Including NBFCs, Rural co-op banks, Small finance banks, Housing Finance Institutions, or Microfinance Institutions) to allow or grant payment holiday for 3 months in respect of their Term loan or Home loan obligation falling due between 1st March to 31st May’20. This is also applicable to their working capital facility where interest payment is also deferred for 3 months straight.

What it means: By now, it is already clear that this is not a waiver but deferment.  This is a relaxation from the central bank in this trying times to have an option to repay not now but later. The interest will continue to accrue and it will be added back to the principle on a monthly basis. So a borrower has the following 3 options to repay.

  1. To repay back all at once in June in Bullet payment

  2. Keep EMI the same, but extend the tenor

  3. Keep the tenor same, but increase EMI

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    In the case of a working capital facility, the accumulated interest for the period will be paid after the expiry of the deferment period I .e.31st May in a bullet payment in the immediately following month. i.e. June.

    I am sure some of you must be thinking, What if I have paid installment for March 2020; whether I will get relief for installments due for April, May & June?

    Here, let me clarify that policy spells out clearly that it is for all those, whose EMIs are falling between 1st March till 31st May ’20. So, following the same guidelines every bank has formulated its own board-approved policy. Few banks may consider refunds for March EMI and others are just offering 2 months EMI moratorium.

    Even in case of the drop-down facility (DOD), there will be no drop downs during the moratorium period. However, in the case of quarterly dropdown, if it falls between March to May, it will be deferred. But if it’s due let’s say in June, then that needs to be honored by the borrower.

    Secondly, you may surely ask if non-repayment of EMI will be considered as default, and credit history (CIBIL report or credit rating agency reported) of the company or individual will be adversely impacted. So, RBI has clarified that such accounts should not be reported as defaulters. Therefore, credit rating agencies will not downgrade such accounts.

    Lastly, there are few exclusions to the policy. Let us also understand the same.

    So, the moratorium facility is only available to accounts that are not NPA or classified as SMA (special mention accounts) as on 1st March’20. Such accounts will continue to get recovery calls from banks and no relief is being provided for these stress assets.

    Borrower benefit section:

    If you are someone who just wants to understand if out of all this, is it advisable for me to Opt-In for Moratorium or should just Opt-Out? The answer to this can be as simple as, it depends on how much cash flow do you have at hand. If you are already struggling to repay your obligations, then it does not make sense that you strangle your finances in such an uncertain scenario and continue paying regular EMIs. However, if you have sufficient cash flow to pay for the next 2 months after honoring all the obligations without a stress crease on your forehead, then you should continue paying EMIs.

    The reason is simple, if you can afford, why pay extra interest. Let me present to you an illustration which will clarify a lot of your doubts.

    Products

    Rate

    Amount

    Total Tenor

    Present EMI

    Outstanding Term

    Moratorium opted for

    Revised EMI (same tenor)

    Extra Term (same EMI)

    Business Loan

    18%

    5,00,000

    36

    18,076

    30

    2 Months

    18,618

    4 months

    Personal Loan

    15%

    2,00,000

    24

    9,697

    18

    2 Months

    9,940

    3 months

    Machine Loan

    13%

    20,00,000

    60

    45,506

    50

    2 Months

    46,492

    4 months

    Term Loan

    10%

    50,00,000

    84

    83,006

    60

    2 Months

    84,389

    4 months

    Mortgage Loan

    9%

    75,00,000

    180

    76,070

    150

    2 Months

    77,211

    7 months

    Home Loan

    8.5%

    90,00,000

    240

    78,104

    220

    2 Months

    79,211

    10 months

    Disclaimer: Figures in the illustration above are approximate. Actual figures may differ.

    This table shows how it impacts your future cash flows if you are deferring your present EMIs. An interesting thing to note over here is, these extended tenor are the result of accrued interest added back to principle and EMI is recalculated. So, if you are not at a cash tight position, this is not advisable.

    As discussed above, RBI also announced a reduction in repo rate from 5.15% to 4.40% i.e. 75 bps. So, current borrowers who have their loans from commercial banks linked to Repo rates will be passed on this reduction. This will surely reduce the EMIs of the borrowers if they do not opt for an EMI moratorium.

    Here, let me show you another illustration.

    Products

    Present Rate

    Amount

    Total Tenor

    Present EMI

    Reduced Rate

    Revised EMI (same tenor)

    Term Reduced by (same EMI)

    Term Loan

    10%

    50,00,000

    84

    83,006

    9.25%

    84,389

    3 months

    Mortgage Loan

    9%

    75,00,000

    180

    76,070

    8.25%

    77,211

    15 months

    Home Loan

    8.5%

    90,00,000

    240

    78,104

    7.75%

    73,885

    29 months

    So, if you Opt-In for a moratorium, the major benefit of passing on the rate cut is actually offset against the Extra Term extended.

    Again in the same circular, understanding the challenges which business owners will have to face to revive their businesses in the short run, RBI has also advised banks to formulate their own policies to extend additional working capital by recalculating drawing power by reducing debtor or inventory margins. Therefore, a business owner needs to carefully understand their cash flow and ask for an additional limit if it’s really required.

    Finally, to conclude we would like to mention, the entire world is fighting this pandemic and all the governments are busy in containing this. However, much appreciate efforts by the Indian Govt. and particularly by RBI to ease out the economic impact on the businesses. On this note, we will end this topic here.

    This was a small effort we did to help business owners take decision easily, who is already engaged in working on how to get out of this situation somehow.

    If you are a business owner and still not clear about what to do, whether or not to opt for Moratorium, please sign up and our expert will guide you for a FREE session worth Rs. 2500/- (for 1st-time users only).

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