Another take on Loans
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.
January 18th, 2006 at 3:24 pm
nicely written PK… industrial loans and private banks don’t go well
January 18th, 2006 at 4:09 pm
good one. when the big business man ask the banks to give him crore’s of Rs, they are giving without thinking but when a small handbusiness man ask some lakh Rs. they are asking thousands of questions.
January 22nd, 2006 at 9:16 am
Dear PK, I am not an ecomomics/financial guru either. Would like to weigh in with my comments.
You are equating industrial loans with consumer loans. To me, plain and simple, risk determines the interest rate. It does not matter if you are a industrial borrower or a consumer. There are high risk industrial borrowers, and who have to literaly sweat out to raise capital. Agencies like CRISIL(hope I am right), Moody’s, S&P, and others routinely rank industries based on risk. Recently, industrial giants like General Motors and Ford Motors were reduced by the lending agencie to ‘junk’ status. What does it mean? If they go back to the captial market or banks to borrow money, they have to pay a huge premium to coax money out of lenders. Pretty pathetic!!
Another point is that industrial loans are not simply money transactions. Depending on the structure of the loan and the risk, the lenders take stake in the company. Good example is Venture capaitalists. They do provide money, sometime, without any interest or traditional money lending structures. However, they do get equity stake in the company and aggressively work on making the venture success. That is how, they are get their returns.
I am sure this topic can be expanded and further clarified.. However you get the point.. Interest rate is very much associated with risk. If there is a risk of default, you mitigage the risk with either higher interest rate, collaterals or any other financial means to secure your capital. Government weighs using their monetary levers of RBI with their control on interest rates and fiscal levers like tax policies, grants etc.
regards
-CV
January 22nd, 2006 at 10:45 am
CV
i get your points. i also know that financial institutions have their own crew as directors etc in the company to which they provide loans. i don’t deny that.
And yeah i did try to equate consumer loans with industrial loans.
my point is, from an economic health perspective, credit offtake to industrial houses or to someone to start an industry has more impact than say unleashing consumer loans to travel abroad etc.
regarding risks, if banks consider consumer loans as riskier then are they not better off sanctioning loans to corporates? i am rather curious to know about the role of multinational banks in this scenario. any idea of the mix of industrail credit to consumer credit?
am not saying MNC banks r villains. i just wanted to debunk the notion that they r here to provide loans to consumers to sustain economic grwth blah blah.
i am saying it makes much more business sense for them to give loans to conusmers for short terms at exhorbitant rates than give loans to industrial houses for long term.
Regarding credit rating agencies, well am not good enough to argue on that. need to read more.
January 22nd, 2006 at 10:47 am
NK
danks man
jeevan
adhey daan!
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