ExpertDabbler

Prem’s poser about the effect of not taking loans from an economic perspective prompted me to write this. One disclaimer though,I am also not an economics guru. But then I am never ashamed to reveal my ignorance.

To the best of my knowledge, the impact of loans from an economic viewpoint is based on the ‘Multiplier effect‘ concept in Economics.
According to this concept, there are some unused resources in an economy (land, labor,capital etc). By increasing demand in the economy, it is possible to increase the utilization of these resources for economic benefit(boosting production). This is my understanding. But maybe some economics guy can throw more light.

But having said that, this concept is more relevant to credit given by financial institutions to industrial houses.

But the downside to it is that financial institutions are required to lend money to industrial houses at very less rates of interest. Like, say 4% etc.

On the contrary take the case of retail consumer credit. For example take the case of credit cards. The rates of interest for credit card debts is about 2% per month. Which comes to about 24% per annum. No wonder banks offer lifetime free credit card.

Even in the case of personal loans, the rates of interest charged is usually in the order of 16% per annum. Not to mention the numerous processing charges, fees etc.

Also when you provide loans to a gullible salaried employee, the balance is always in favor of financial institutions when it comes to loan default or some other dispute. He is after all an individual. He will not resort to legal remedy that easily.

The methods employed by some of the private sector banks for loan recovery would put the eetikaaraan in old thamizh movies to shame. More on this later.

The industrialists on the other hand would demand lower rates of interest in view of the huge loan amount. I also suppose RBI has some norms with regard to the rates of interest for loans offered to financial institutions.

From a business standpoint consider two scenarios.

Case 1:
1 crore loan given at say 5% for a leading industrial house.

Case 2:
100 personal loans of Rs 1lakh each where each fetches a rate of interest of 16% pa.

It does not take a genius to figure out which is profitable, right?

Of course banks justify these high rates of interest on the basis of lack of security for personal loans and credit card debts. But from what I have seen as an observer, no bank will give a personal loan without signed cheques in its favor. A signed cheque is an acknowledgement of debt according to Negotiable Instruments Act(again to the best of my knowledge).

Also add to it the prospect of harassing the consumer in case of default. All this is not possible when you are dealing with powerful industrialists.

I would like to know one thing. Does the likes of Citibank, HSBC, Standard Chartered give loans for industrial projects if at all? I am not sure. Only public sector banks sanction loans for starting industrial projects.

If the banks in India are so slush with funds, why not lend it to industrial projects for lower rates of interests? This will generate employment opportunities. But banks are here to make money.

In my layman’s opinion, a loan given for industrial houses will have a greater impact on economy than all these personal loans or credit card debts. But these kind of loans are proliferating mainly because of the profitability aspect of these institutions.