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Supreme Court disallows Charging of Compound Interest/Penal Interest during Moratorium

Ashish M. Shaji

| Updated: Apr 10, 2021 | Category: Latest News

Supreme Court disallows Charging of Compound Interest

The Supreme Court directed that there would be no charging of compound interest, interest on interest, or penal interest on instalments that were due during the moratorium period from 1st March 2020 to 31st August 2020 on any borrower, regardless of the amount of the loan. It further directed that if the interest has been collected, it should be either refunded or adjusted towards the next instalments. 

What is Moratorium?

Moratorium refers to the period during which a borrower is not required to make payments which means during this period, the borrower is permitted to halt their payments.

In view of the Covid-19 pandemic, the RBI[1], as a relief measure, permitted a 3 month moratorium on term loan and credit card payments. Lending institutions were asked to defer the EMIs of their customers, opting for the moratorium scheme.

It may be noted that a moratorium is generally affected in response to a crisis like in the aftermath of earthquake, flood, droughts, or an emergency. On occurrence of such instances, moratorium on some financial activities can be granted by the government or by the central bank. It is removed when normalcy sets over.

Charging of Compound interest/ Penal Interest during moratorium: Supreme Court Directions

The Supreme Court stated that there will not be any charge of interest on interest/compound interest/penal interest for the period of moratorium. Further, the amount accumulated as compound or penal interest or interest on interest during the moratorium period on term loan EMIs should be given as credit /adjusted in the next instalment of the loan amount.

The bench of justices Ashok Bhushan, R Subhash Reddy, and MR Shah stressed the fact that additional interest in the form of a compound or penal is generally collected from loan defaulters. When the payment of instalments has been deferred already during the moratorium, then what is the need to burden borrowers who are already reeling under the financial losses of the Covid-19 pandemic and lockdown.

Charging of Compound interest/ Penal Interest during moratorium: Background of the matter

The RBI issued a notification on 27th March 2020 to allow banks and financial institutions to provide a moratorium of three months on payment of all instalments of term loans falling between 1st March 2020 and 31st May 2020. The period was extended by another three months.

The petitioners had sought an extension of the moratorium to 31st December and then again sought an extension up to 31st March 2021, saying that the present situation demands the same.

In November, the centre had urged the court not to intervene and provide further relief to borrowers as the government was already on top of it. The Court was informed that many relief packages and schemes were worked out, and the court’s intervention in fiscal policy issues was not required. In November, a bench led by Justice Ashok Bhushan directed the centre to implement the decision taken by centre to forego interest for 8 specified categories up to 2 crore rupees.

Court’s observations

The bench found that there is no rationale in the policy of the centre to limit the benefit of waiver of compound interest to only certain loan categories. The Court ruled this policy of the centre arbitrary and discriminatory and stated that there will not be any charge of interest on interest/compound interest/penal interest for the period during the moratorium and it shall be refunded and adjusted in the next instalment of the loan.

Conclusion

The ruling of the apex court (disallowing charging of compound interest, interest on interest or penal interest) has come as a major relief for the borrowers. While refusing the plea to extend the moratorium period, the court observed that there is no justification to charge interest on interest or compound interest for the moratorium period. The top court delivered the verdict on a number of petitions seeking reliefs.

Read our article:An Analysis of Covid-19 regulatory package by RBI

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Ashish M. Shaji

Ashish M. Shaji has done his graduation in law (BA. LLB) from CCS University. He has keen interests in doing extensive research and writing on legal subjects especially on criminal and corporate law. He is a creative thinker and has a great interest in exploring legal subjects.

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