By: Subhashini, Asstt. Editor-ICN
NEW DELHI: As we all know, the Indian banking system is facing a serious problem of NPA (Non Performing Assets) and the cause behind this is the deep rooted banking policies prevalent in India since the nationalization of banks. If we carefully preview the loaning policies of the banks, we would observe that the banks are more concerned with the value of the collateral instead of being concerned with the probability of the borrowers’ businesses being successful or unsuccessful. In this article, I present a new concept regarding banking loan policy which would create fearless entrepreneurs.
Drawbacks of the current loaning policies
Let us throw some light upon the big business houses and the powerful influence that they have on the banks. The behaviour of the banks is quite different if the loan is applied by a reputed and a strong business firm. Neither do they worry much about the collateral offered by the firm, nor do they check the future success of the project for which the loan has been applied. This kind of policy is clearly very dangerous for the development of the economy. Banks are relatively liberal if a loan is required by a big firm dealing with a lot of money, even if there is a big risk involved. However, they are very conservative in sanctioning loans to small firms or start-ups where the risk involved is much smaller.
Psychology of the banks
The psychology of a banking institution can be explained through a crude example–
Say there are two types of cafes- first one being expensive, with all the pomp and show; and the second one, cheaper, with moderate presentation but exactly with the same menu as the first one. Now, people would prefer to dine at the first cafe and would also be willing to pay a higher price for the exactly same dish, which they could have bought at a cheaper price at the second cafe. They prefer to go to the first one, even when the cafe’s kitchen might be unhygienic, but choose to ignore the second one, even when they might be maintaining proper hygiene and cleanliness.
Banks also have a similar psychology. They are willing to lend money to big business houses, on the basis of their pomp and show and simply ignoring any kind of malpractices that might be going on internally which might result in a huge loss for the bank once they sanction the loan. Big firms usually go on to take higher risks which might cause huge losses for the banks. This is because these firms show that they can afford losing their collateral. On the other hand, banks are reluctant to give loans to small and less reputed firms even when most of their work might be transparent and logical. Smaller firms avoid taking huge risks because what they hold at stake, i.e. their collateral is highly important to them and they want to protect it at any cost. So, they would not pursue any sort of activity that involves a very high risk which might eventually lead them to bankruptcy.
Concept of a two way system to protect the spirit of entrepreneurship through banking finance with the participation of insurance sector.
I am presenting a new concept regarding the above which could be eventualized with the help of simple and smooth co-ordination among the banks, insurance companies and the Government.
- Firstly, banks should keep provisions of an amount equal to the loan which have been disbursed to each of the small entrepreneurs or start-ups.
- Banks should co-ordinate with the insurance company and make it mandatory to get small loans insured where the premium should be paid to the insurance company by the borrowers themselves either in one time or as a part of EMI.
- There should be a close understanding between the banks and the Government for the success of this policy.
This policy can be well explained by an example. Say a person goes to a bank for a loan. If the current banking policy prevails, he would be asked for collateral, so that if he defaults, the bank sells off his collateral and recover their losses. Say, the borrower fails, and his collateral is seized from him. This would either lead him to depression and he might commit suicide in an extreme case, or he might try to earn money illegally or else he might start looking for jobs. If he earns illegally, he would be creating a law and order instability; if he takes up a job, he won’t be earning what he could have, had he got another chance to expand his business reach. Hence the possibilities arising from the current policies do not seem pleasing.
Now if he is given an opportunity to get the loan once again, the probability of his business being successful would increase. This is because his failure would have given him an experience that would come in handy when he invests the money for the second time. He would use this money judicially and wisely and this would increase the chances of his business being successful.
But how would he be getting the money again to give his business a second chance?
In my view, banks should make a policy to cover the borrower’s risk bothinternally and externally. Banks should keep an equal amount of the loan they give to borrowers in their special provision. There should be an arrangement between the Ministry of Finance and the banks that the Ministry should support the banks in a regular manner through a special provision made for such requirements. For the Ministry to have this required amount, the taxation structure and the method of collecting arbitrary contributions from the general public of the country should be revised. A small contribution from the taxpayers and the general public would create an income generation source required for this establishment.
Participation of the insurance sector
There should be a mandatory policy for all the borrowers to take insurance for the risk coverage of the money that they have borrowed from the bank for their business. It would be an additional way to secure the risk coverage. If such a policy is brought into practice, insurance companies would have a huge number of people getting insured and so the amount of premium they would receive would increase. It is quite obvious that the failure rate of all the borrowers cannot be 100%. This means that the premium paid by the successful entrepreneurs to the insurance companies is nothing but their profit which could be used for the further financing to giant businesses with proper reversible security.
Let us explain this through an example. Say there are 10,000 small scale entrepreneurs who are seeking for funds from the bank to start up their business. The insurance company requires each of them to pay a premium of Rs. 10,000 against the loan amount of Rs. 10 lacs. Out of these 10,000 entrepreneurs, say five of them fail, i.e. the failure rate is 0.05%. As per the policy, the bank would have maintained the provision to cover the borrowers’ risks as per 10,000 people. Moreover, the insurance company would have received premium from these 10,000 people. 0.05% failure rate would mean that the insurance company would just have to pay to the bank for these five people who failed. This means the remaining amount is their profit.
Number of borrowers=10,000
Money borrowed by each=Rs. 10,00,000
Premium paid by each=Rs. 10,000
Total premium received by the insurance company=Rs 10,000X10,000
=Rs 10 cr
Assume 5 out of 10,000 fail. Then,
Compensation by the insurance company=Rs. 10,00,000X5
=Rs. 50,00,000
Profit made by the insurance company= Rs. 10cr- Rs 50lac
=Rs. 9.5 cr
Additional provisions available to the banks
By following this policy, banks have to arrange additional provision equal to the amount of every loan disbursed.
Loan disbursed by the bank= Rs.10,00,000
Provision made by the bank behind this loan=Rs.10,00,000
Provision for 10,000 borrowers= Rs. 10 cr
This 10cr is the amount maintained in the treasury of the bank for meeting out any big risks and putting the bank into a commanding position.
Now you might find this a little impractical, as to why and how would the Ministry of Finance fund these banks for making additional provisions regarding every disbursed loan?
WHY?
- This policy would create a number of fearless entrepreneurs throughout India and every such business would provide local employment. So first of all, the pressure on the Government to provide jobs would reduce. Secondly, people looking for jobs would not need to travel to far off places.
- If the government finds this practical, it would further encourage the private banks and NBFCs also to adopt this policy.
- Currently, the banking sector is covering a very small proportion of the total population of the country. After adoption of this policy, the banking services would spread very rapidly as the aspirant entrepreneurs are present throughout the country.
HOW?
- Recently, we have witnessed the success of the Pradhan Mantri Jan Dhan Yojna, where the government could collect revenue of 35 thousand crores in a very short span of time. Even though the opening of an account did not require people to hold any balance, yet most of them deposited a minimum amount of money on their free will. Similarly, if this policy is adopted and the Government appeals to the general public to make a very small contribution towards this purpose, I am very sure that a huge amount could be raised for maintaining the additional provision with the help of Ministry of Finance.
- A substantial amount could also be raised if the government appeals to all the taxpayers and salaried people to contribute 0.1% of their income towards this purpose.
Government has collected revenue of Rs 6,96,200 crore in the fiscal ending March 31, 2015. Just take 0.1% of this amount for the purpose of this policy. The amount is 696.2 crore. Now, one can estimate the real figure if the income taxpayers are contributing 0.1% of their taxable income.
Trial and testing limit
Provisions should be made that the borrower would be offered the loan not more than three times and each time he fails, the losses would be covered up by the insurance company. So this kind of policy would boost the spirit of entrepreneurship among individuals by increasing their opportunities to get the required fund for their start-up.
Problems with this system
Since the small firms would have the liberty of receiving the loan thrice, there would be an added risk for the banks, since now the borrowers would be aware that if they default, their losses would be covered by the insurance company. This would increase the problem of moral hazard. To avoid this kind of a situation, a separate body should be formed solely directed towards the supervision of the borrowers and to keep a close check on the borrowers’ activities so that they do not go on to take huge risks which could possibly result in a loss for the bank or the insurance company. This supervising body should also keep a record of the defaulters, in order to make sure that they do not get any kind of loan from any bank in the future under this policy.
Specific guidelines or covenants should be issued to the borrower, restricting his activities within what is considered as a safe limit. This would help reduce the possible law and order chaos that might prevail if this system is initiated.
Benefits of this new system
This new system of banking has many significant benefits:
- This new system would give a boost to the spirit of entrepreneurship, as the chances of small firms getting a loan would increase.
- People would find business attractive and would prefer to become self employed, because of these added benefits provided by the banks.
- There would be a generation of employment through increased entrepreneurship by this policy. This would decrease the load on the Government of India to pay the salaries of so many.
- Research and development would increase because the self employed people would be conducting them on their own. Hence, Government spending on research and development would decrease.
- Small businesses would be established in the villages, which would increase the rural employment and their economy.
- In the rural areas, the farmers, apart from their hours of farming, could also find part-time employment in these small businesses, thus gaining higher profits and prosperity.
- People would develop professional skills, and the future generations would also have another source of earning locally and thus would not face much unemployment.
- The financial stability of the banking system would be strengthened because the provision against every loan would always be there in the treasury of the bank.
- The insurance sector would experience a heavy boost because the number of people getting insured would increase to a large extent.
- Entrepreneurs would be helping each other indirectly by making required series products, i.e. the finished product of an industry would be serving as a raw material to some other industry.
- When any entrepreneur takes a loan against the collateral security, his assets are always in danger. This increases the mental pressure on him because if he fails, his personal property would be seized. But, if this new system is introduced, he would be psychologically free as he would know that the loan is insured.
If this new loaning policy is adopted, it would have a twofold advantage. Firstly, there would be a rapid economic growth and the unemployment would decrease as a number of new entrepreneurs would enter the market with new emerging opportunities of employment for the local aspirants. Secondly, the backbone of the banking sectors would be strengthened to a great extent. Besides, the insurance sector would grow as a by-product.
