Life Insurance: A View

What is Life?   Life is our sojourn in this world.   Our journey through time from birth until death.

What is Life Insurance?   Life Insurance is a kind of security created or contrived to meet life’s various challenges, primarily untimely death, disability, loss of livelihood, old age, etc.

Life Insurance is a sort of shield meant to help us face up to the uncertainties of life.   An uncertain future, that is may bring in its wake problems, most of which could be resolved with the aid of money!   That, in fact, is the primary purpose of Life Insurance-to provide money either in lumpsum, or in instalments, in times of our need.

Of course, there was a time when life or any other type of insurance was non existent, and still people live their lives, and enjoyed it!   However, in the context of the modern industrialized world that we live in today, insurance is perceived as a must have, like, perhaps, medicines.   (There was a time when humans consumed much lesser quanities of medicines, yet lived healthy lives!)

Let us take the case of the Adams family.   John Adams is a copywriter with a Advertising firm and his wife Mary is a Home Maker.   The Adams have two school going children, Jacob, and Julie.   It is,  by all accounts a happy, contended family.   However, the peace of this family could be jeopardized by scores of reasons, some of them beyond the comprehension of the family.   Let us study a hypothetical situation faced by the Adams family, on account of the untimely death of John, the sole earner of the family.

Untimely death,  not an uncommon phenomenon,  can leave the surviving members shattered for the rest of their lives.   For one, they have to go through the trauma of losing a loved one, that shall never come back.   And for another, the family has to worry about providing for their own necessities of life, that were earlier the concern of the earning parent.

The full impact of and import of a regular income becomes apparent to the surviving members of the family, when they have to actualy pick up the tab for their daily groceries, the house mortgage, school fees, transportation expenses, and such others there were earlier taken for granted.

This situation can be further compounded by the debts availed of by the deceased parent, most of which, in fact, might have been taken for the welfare of the family.   Regardless of the reason and rationale for the debts, the fact is that the surviving members of the family would find it burdensome to clear them off.

Any person could be overwhelmed by the above situation, now faced by the Adams family, that is truly devastated by their loss.   Adams’ wife, Mary, is now left to fend for herself and her family.   She has to find some work to send the children to school, to pay for the house mortgage, the utilities, and also small luxuries like a chocolate for the children.   Mary’s situation is enough to leave anyone disturbed and thoughtful.  No one would wish to face such a situation.

Enter Life Insurance.   In the example above, let us assume, that John, who was the sole earner in the family had obtained sufficient life insurance against this kind of nasty surprise for his family, that is, his untimely death.   What would the future be like for the family?

Of course, the trauma of the family would be no less for their permanent loss.   However, in practical terms, the insurance of the deceased parent would help reduce the impact of the financial blow to the family on account of his untimely death.   The proceeds of the insurance policy would literally take the sting out of the financial problems that the family is likely to face now.   In fact, the maximum benefit of the insurance money would be in the imediate aftermath of John’s death, when it would be most difficult for the survivors to gather their wits and start planning and working towards an alternate source of income for the family.   Thus, life insurance, at least in this case, has lived up to the promise of a “friend in need”.

Not only untimely death, but also disability of a permanent nature and old age, though a natural phenomenon, can cause trauma and anguish to a family that is not prepared to face up to the financial challenges thrown up by the uncertainties of life.

Now take another scenario of the Adams’ family having to survive without insurance, after John’s death, and one can imagine the agony of the family, especially the widow,  left without a regular income, and two school going children to take care of.   The trials and tribulations that the widow and her children would have to undergo provide a fair picture of the importance of life insurance.

 

 

FINANCE: CREDIT CARDS PART II

In the previous article on Credit Cards, we had a glimpse at the credit card business, and how it works.   In this article, we shall take a look at the advantages and disadvantages of the credit card to the parties concerned.

 

Advantages of Credit Cards:  Credit Cards offer several advantages to the cardholers, the issuers and  the merchants alike.   Some of the important advantages are discussed below:

To Cardholders:  Among other things, the Cardholder is relieved of the burden of carrying large amounts of cash.   Carrying cash in large quantities is not only bothersome, but also risky, especially for old people.   The credit card is  a versatile payment system that gives flexibility to the Cardholder, who can buy goods and services from a vast choice of merchants, throughout the world practically.    And by doing a little research, he can the land the best  deals possible  from the merchants.   The card companies and their agents offer several incentives to cardholders to get them to use their cards.   They take advantage of special ocassions, like festivals, etc to offer special discounts and other such inducements to increase their business.   Credit card companies tie up with merchants and other vendors to offer special rates, discounts etc on usage of the cards.   Another popular incentive offered is called the ‘cash back’, wherein the cardholder is refunded a part of the money he spends on purchases through his card.    Credit cards also enable one to shop online, obviating the need to go physically to the market or the mall.   Especially during peak seasons of shopping, it can be quite tiresome, to go through the grind of visiting a shopping mall to make one’s purchases.   Credit cards are especially useful in making purchases of items that don’t require physical examination.

With increasing competition for the customers’ favors in this area, cardholders are enjoying a bonanza in the form of interest free credit, credit of points for amount spent that can be utilized for availing other services free of cost, or at concessional rate, so on and so forth. 

To Merchants:  In a way, credit cards increase the purchasing power of the consumer as they enable the cardholder to buy now and pay later.   And it is human nature to spend, if one can.   The credit afforded by the Banks through the credit cards  often means more business to the Merchants.  

That apart, they charge a commission on each  card transaction, as they do not get paid immediately for the sale.   Invariably, the amount of such commission charged by them is rounded up to the higher side.   That is they end up getting more than the loss by way of interest incurred by them.   Further, the risk of non payment is practically non existent, once the transaction is electronically authorized.   The merchant is assured of being reimbursed for the credit sale effected by him.   In due course, the merchant’s account with his Bank is credited with the amount of the credit sale.

Also the merchant saves money on  overheads and administrative expenses, when he transacts through the medium of credit card, as he does not have to deal with large amounts of cash, especially small notes and coins.

To Banks:  Banks that issue credit cards to their customers get a commission from the Card Issuer for each card they issue.   The facility of credit cards attracts more customers to a Bank, and generates other business for them.   It enables Banks to engage in cross-selling of products and maximize their revenues.

Further Banks charge very high interest rates for the credit offered through the credit cards.   Especially in case of default, the cardholder literally pays through his nose.   This interest charged by the Banks is way beyond the monetary loss suffered by them on account of late payments by the cardholder.

Disadvantages of Credit Cards:  Now a look at the negative side of the credit card business, and how it adversely affects the same parties that also enjoy its plus points.

To Cardholers:  “Neither a lender nor a Borrower be!”.   Of course, in the modern economic system, it may not be practicable to pursue this goal.   However, it  is a fact, that, credit cards have ruined many a life, on account of indiscriminate usage by the cardholders.   When credit is available easily, the tendency of the cardholder is to buy goods and services that he does not really need, or to buy more expensive items that he would normally do.   The availability of credit, and that too without going through documentation and other formalities, like in a conventional loan, makes it even more tempting for the cardholder to spend.   Then there is the necessity of keeping up  with the Joneses.

There are any number of cases of cardholders going bankrupt due to their inability to pay off their card dues.   Apart from that, there are security issues also involved like the loss or theft of cards, misuse of cards by  others through fraudulent means, etc.

To Merchants:  Disputes in credit card transactions are a not-so- rare occurance, resulting in a lot of avoidable administrative and sometimes, legal work and expenses, for the merchants.

Fraudulent usage of the cards by crooks, is another headache for the merchants.   With increasingly sophisticated methods being adopted by fraudsters, merchants are forced to be extra vigilant, and thereby incur additional expenditure in the process.

For Banks:  For the Banks, of course, the number one problem is with payment defaults.   Monitoring the usage of millions of cardholders, and ensuring prompt payments from the customers is indeed a mammoth task.   Further, collecting overdues from defaulting cardholders can present administrative and legal hassles costing good money.   And fraudulent usage of cards is equally worrisome to the Banks.

Unlike in a regular or conventional loan, Banks do not follow any formalities in allowing credit to the cardholders.   Once the Bank grants a credit card facility to the customer, and so long as the customer keeps within his limits, the Bank does not bother customer.

Conclusion:   On balance, it may be said, that credit cards have contributed a lot of good to society at large, facilitating payments, that would otherwise be quite cumbersome, and risky.   The negative aspects of the credit cards may have to do more with human psychology, though it cannot be denied that usurious interest rates charged for credit card transactions have given them a bad name.

                                                                                                    Concluded

FINANCE: CREDIT CARDS PART I

Introduction: Activities related to  Trade and Commerce are as old as mankind.   They have evolved over time and space, from the very rudimentary to more and more sophisticated practices.   Today, we have reached a stage where one could buy practically anything from anywhere in the world, online.   A comuter system, with internet connection is all one needs, to access the world’s markets, apart from the local ones, of course.

Now, when we talk of buying things, whether online, or otherwse, the most important thing that comes to mind is the payment aspect, apart from other issues like delivery of goods, etc.

How does one make payments for purchases made?   One way, of course, is to pay by cash.   And then there are other ways like cheques,  drafts, etc.   But if one has to pay a large sum of money for purchases made, it may not be convinient to carry so much cash, apart from it being unsafe.   Moreover, the seller of the goods and services may not always accept personal cheques, or even drafts, because they take time to realize.   That is they are not immediately encashable, which results in interest loss to the seller.   Also, it may not be practicable for the buyer to purchase a draft each time he makes a purchase.

This is where the Credit Card comes into the picture, to facilitate payment and smoothening the rough edges of the transaction.

Definition of Credit Card:   A Credit Card is simply a Card that enables the owner to purchase goods and services on Credit.   A credit card transaction involves the issuer, the agents or facilitators, the card owner and the member establishment, or the merchant that sells the goods and services to the card holder.

The system operates like this.   There are companies that issue cards, through their agents, the Banks, to eligible customers, who fulfil the criteria laid down by them.   Among other things, the Banks evaluate the creditworthiness of the card applicants, before deciding to grant them the facility of the Credit Card.   Two of the most famous and popular credit card companies are the Mastercard and Visa.

Normally, Banks grant two types of credit limits to the card holders.   One, the overall credit limit, the other, a cash limit as part of the overall limit.

As an example, say, American Banking Corporation(ABC), on behalf of Mastercard, issues a credit card to Mr. John Walters.   After evaluating Mr. Walters’ financial status, ABC determines that he is worthy of extending a overall  credit line of USD: 20,000.00 through his credit card.  And a cash limit of USD: 5000.00 within the overall limit.   That means, Mr. Walters can buy goods and services for the value of USD: 20,000.00.   Or he may buy goods and services in the value of USD: 15,000.00 and draw cash advance of USD: 5,000.00.   Or he may avail of a cash advance of USD:5,000.00, the remaining limit of USD: 15,000.00 remaining unutilized.   That is, at any given point of time, Mr. Walters would not be eligible to spend more than USD: 20,000.00 using his credit card.

Using the Credit Card:   Supposing Mr. Walters wants to buy a pair of sunglasses.   He visits a local optician, and having checked out a dozen pairs, zeroes in on a pair of Prada sunglasses, that he thinks would fit him perfectly well.   The cost of the sunglasses is USD: 199.00.   After making his choice,  Mr. Walters hands over his credit card to the Cashier, who swipes the card through what is called a reader.   This electronic device is programmed to do the job of obtaining the necessary authorisation from the card issuing Bank, in this case, ABC, thus sealing the transaction, as it were.   Once the authorisation is recieved by the optician’s establishment, the goods, the Prada sunglasses are delivered to Mr. Walters, who is now the legitimate owner of the same.   The optician would then have to deposit the authorisation slip in his own bank, to get the credit from the card issuing Bank.   As this process takes a day or so, the optician, or the merchant, usually charges a small commission on the sale, to compensate himself for the delay in receiving credit into his account.   Once the credit is received in the Merchant’s account, that is the end of the transaction as far as he is concerned.

Now, let us assume, that, after selecting the pair of sunglasses, Mr. Walters finds that he has lost his wallet containing the credit card among other things.   An embarrasing situation, no doubt.   But by following a relatively simple procedure, Mr. Walters can be up and about with a duplicate card within a short time.

Normally in a case as above, the careholder is expected to fill out the relevant forms available with any Merchant, giving details of his card etc., and informing the same to his Bank, and the card issuer.   Further, he has to report the loss/theft to the local police authorities.   Upon receiving this requisition from the cardholder, the Bank and the card issuer take suitable steps to prevent the misuse of the card by passing on this information throughout the network of their merchants and others concerned.   After satisfying themselves about the genuinness of the cardholder’s claim regarding his lost/stolen card, the Bank issues a duplicate card to him.   By acting promptly according to procedures, the cardholder can save himself a lot of trouble, not to speak of monetary loss.

As for the cardholder, he has, no doubt, got delivery of the sunglasses.   But then, he has to make good the amount of  money advanced to him by his Bank, to purchase the pair of sunglasses, within the stipulated time.   Some Banks may afford the option of paying the minimum amount of dues, instead of the full amount, with the rest payable within a certain period of time.   It is upto the cardholder to pay off the entire dues in one go.   He may also instruct his Bank to effect such payments through his account.   In the above example, where Mr. Walters purchased a pair of sunglasses for USD: 199.00 , supposing the Bank requires payment of a minimum amount of due, say, USD: 50.00, within 15 days from the date of purchase, and the remaining amount, within another 25 days.   Let us assume this transaction took place on the 15th of March.   In this case, Mr. Walters would have to pay USD: 50.00 by the 30th of March, and the remaining amount of USD: 149.00 by the 14th of April.

It is a standard practice for the card issuing Bank to charge penal interest on dues that are not cleared within the stipulated time.   And interest is charged on the full amount of the transaction, and not on the overdue amount alone.   In the above example, if Mr. Walters pays USD: 50.00 within time, but fails to pay the remaining balance, his Bank would charge penal interest on the entire amount of USD: 199.00, till the time of its repayment in full.  

An important point to note here is that, the interest rates charged by Banks for defaults in credit card payments are probably the highest for any kind of  transaction.   In fact this is a sore point with the cardholders in most of the countries.   Even the interest charged on the regular credit, availed of, by the cardholder, attracts a very high rate of interest.  

Complaints galore against the alleged unethical practices of Banks and card companies in milking the cardholders at the slightest pretext.   Unjust enrichment is a very common compliant against the card issuers and their agents.

The intense competition among the card companies has led to several unfair trade practices where card companies lure new customers with goodies that eventually land the carholder into avoidable and unneccessary trouble.   One such common ruse used by the card companies is to offer attractive gifts upon signing up for the card.   It is only much later that the poor carholder realizes the ‘real value’ of the gift, in the form of exhorbitant bills and aggressive recovery procedures.

In the second part of this article, we shall discuss the advantages and disadvantages of the credit card.

                                                                                        To be continued.

INVESTMENT: MUTUAL FUNDS

Introduction:  Investment may be defined as the application of money or money’s worth in a process that begets more money.   In other words, the multiplication in the amount of money, as a result of channelling the same through a process that adds incremental value to the original amount.

Many are the ways in which wealth may be created and multiplied.  There are innumerable avenues for investment, each wiuth a distinct purpose, and corresponding end result.

One may invest in gold, or other precious metals like silver, platinum etc.   One may invest in commodities like wheat, soya, corn, etc.   One may invest in stocks of companies.   Or one may invest in Mutual Funds (MF).   This article deals with the subject of Mutual Funds (MF) briefly.

Definition of Mutual Fund(MF):  What is a MF?   A Mutual Fund is a joint effort at Wealth Creation.   Practically, a group of people come together and invest in a particular security/securities for common good.   This group of people are banded together institutionally in the form of a fund, or an agency that takes care of their investment issues.

It is only logical, then, that, when a diverse group of people with different educational, cultural, economic and other backgrounds come together, there must be a common set of rules, customs, and practices to bring about harmony in their functioning, in order to achieve their common goal.

The legal constitution of a Mutual Fund(MF) depends on the laws prevailing in the country of its establishment.   For instance, in the United States, MFs enjoy a special legal status.   In India, they may be set up as Asset Management Companies, with Trustees running the day to day business.  These Trustees are competent people that have a thorough knowledge and understanding of the markets, and have specialised knowledge in their particular subject.

What MFs Do:  MFs are engaged in the business of collecting funds from the members and investing them in various stocks,  securities, bonds, etc for the benefit of its members.   Different strategies are followed by the MFs depending on their philosophy of investment, and the channels of investment available to them officially.

Types of Funds:  There are basically two types of funds, namely, growth funds, and income funds.   Apart from these there is also the Tax Saving Fund.

Income Fund:   A fund whose aim is to ensure a regular income to its members during the currency of the scheme.   Accordingly, the MF chosses the type of companies to invest in, resulting in regular inflows of returns, that are distributed among the members as per terms of the MF.

People who require a regular income and are in a position to make the required investment would find these type of MF beneficial.

Growth Funds:  As the name indicates, the emphasis of the MF here is growth.  In order to achieve this objective, the MF invests in companies that are likely to register fast growth over a relatively short period of time.   As a consequence, the risk factor associated with this fund is also high.

Investors who are not risk-averse and are willing to wait for a decent appreciation of their investments, without requiring a regualr income,  may choose to invest in this type of fund.

Tax Savings Fund:  Apart from the two types of funds discussed above, there is another type of fund offered by a MF with benefits in the form of tax savings, rather than income and growth.   The rationale behind such a fund is  “ADollar saved is a Dollar gained.”  

Normally, these tax savings funds are operated under the auspices of some Governmental regime of tax concessions.   That is, by investing in this type of fund, the investor is relieved of his tax liability to a certain extent.   Investors whose main concern is to reduce their tax liability would find this fund attractive.

Benefits of Mutual Funds:  Two heads are better than one!   What happens in a MF is that several heads come together and exercise their minds for mutual benefit.   Some of the benefits accruing to members of a MF are:

Benefits of Capital:  Supposing there are 100 investors that want to invest USD:1000.00 each in a particular activity.   If they were to invest individually, each one would do so upto his own limit, and they would each benefit to the limited extent of their investment.

On the other hand, if these 100 investors came together and pooled their investments and invested as one entity, then their investment of USD:100,000.00 would fetch each of them, benefits of a USD:100,000.00 investment, instead of a USD:1000.00 one.

In the same way, a MF makes it possible for its members to invest in stocks and securities that would be out of their reach as individual investors.   Large scale investments are brought within the reach of the small investors by breaking up the large investment into smaller parts or share.

Benefits of Expertise:  A lay investor may have an idea of investing, and what to do with his money.   However, to maximize one’s returns and to enjoy the benefits of investing to the full, one needs to have a professional knowledge of the various vehicles  of investment, and also a thorough understanding of the market and how it functions.

This is where the expertise available with a MF comes to the fore.   MFs are managed by professionals who know their job.   By investing in a MF the investor is  capitalizing on the expertise of the Fund Manager, and reaping the benefits of his investment.

Benefits of Diversification:  An investor, in his individual capacity, may not be in a position to invest in a bunch of diverse  sectors, on account of his limited resources.   However, by investing in a MF, he derives the benefit of investing in a cross section of activities and industries.  

By doing that, the investor, on the one hand, benefits from the upswing in any sector in the MF portfolio, and on the other hand, is not adversely affeced to a large extent, on account of the spread of his funds in a variety of sectors.

Other Benefits:  Some of the other benefits of participating in a MF are tax breaks available in certain funds.   Apart from that, a MF offers liquidity, in that, subject to certain restrictions, a MF member may encash his share of investment, in case of need.   Further, the investor need not liquidate his entie holdng, but sell only marketable lots, as specified, and retain the rest of his portfolio.

The investor thus enjoys the benefits of holding a diverse portfolio without acutually investing  in each sector individually.

Conclusion:  MFs, as vehicles of investment, have proved themselves to be versatile, catering to the small and the big investor alike.   They do not require the investor to be investment-savvy to take advantage of them.   In fact, they are meant for people who, either do not have in depth knowledge of the markets, or those that cannot spend the necessary time and effort to do extensive research, before investing.

COMMERCIAL BANKING: FIXED DEPOSIT ACCOUNTS

Introduction:  In a previous article, we had examined various types of depsit accounts, available to the customer of  a typical commercial bank.   In this article, we shall take a look at the different kinds of Fixed Deposit Accounts offered by the Commercial Banks.   Please note that Banks, in different geographical locations, may offer variations of these fixed deposit accounts.   However, most of the commercial banks do offer the following types of fixed deposit accounts to their customers.

Fixed Deposit Accounts:  Fixed Deposits, as we know, are sums of money kept with the Bank, for a specific period, and for a specific rate of interest payable on them.   These deposits are not repayable on demand.   There are certain conditions attached to their repayment before the completion of the period of the deposits, usually a penalty in regard to the interest rate paid on such deposits.

Basically, Fixed Deposits are of two types- Cumulative and Non Cumulative.   In the cumulative type of deposits, the interest payable on the deposits is compounded periodically, unlike in the non cumulative variety.

Non Cumulative Fixed Deposit:  These deposit accounts may be of two types.   One,  that are kept with the Bank for a  certain period that does not fetch compound rate of interest.   For example, say, a Bank offers a non cumulative fixed deposit for 60 days at 2% rate of interest.   And further, it offers same rate of interest of 2% on a 90 day deposit, but on compounded basis.   Likewise, different rates of interest are offered on deposits kept for multiples of 90 days, i.e., 180 days, 270 days and so on.

In the above scenario, say a customer makes a deposit of USD: 100,000.00 for 60 days, at 2% rate of interest.   At the end of 60 days, he would be repaid the principal amount of USD:100,000.00 along with interest of USD:333.00.   A total of USD:100,333.00.   

In the second case, a customer may deposit, say, USD:100,000.00 for one year at 5% rate of interest, with interest being payable monthly.   Here, even though the customer has deposited the money for a period of 1 year that attracts a compound rate of interest, in this particular case, the Bank pays only simple interest, because the customer wishes to draw the amount of interest every month.   Therefore, the customer would be paid a monthly interest of approximately USD:416.00, while the deposit amount of USD:100,000.00 remains with the Bank.   This deposit is repaid at the end of the 1 year period, as contracted, without any addition of interest to it.   This type of deposit is suitable for people who require a monthly income.

Cumulative Fixed Deposits:  In these type of deposits, the Bank pays a compound rate of interest, that is, interest is paid periodically, usually quarterly, as shown in the example on the non cumulative deposits above, and the same is clubbed with the principal amount, and this new consolidated amount becomes the principal for the next quarter, and so on.   This process continues till the maturity period of the deposit, whereupon, the entire amount of the deposit, inclusive of the interest amount, is repaid in lumpsum, to the depositor.

The above type of cumulative fixed deposit fetches the maximum rate of interest, as the same is not withdrawn, but ploughed back into the deposit.   The Bank is able to pay a higher rate of interest on such deposits, on account of the certainty of the tenure of the deposits.   This enables the Bank to take a view of the market, and decide upon the most profitable avenues of investment open to it at that point of time. 

An interesting point to note here, is, Banks may not invariably offer a higher rate of interest on deposits of longer maturities.   The rate of interest offered on different maturities depends upon the Asset-Liability match of the Bank.   That is, the Bank offers a higher rate of interest on deposits of such maturity as it requires funds for.   Suppose the Asset-Liability match of a particular Bank is such that it requires more funds in the 1 year slot rather than the 2 year one.   Then, this Bank would offer a higher rate of interest on deposits of one year maturity than the 2 year ones!

Another type of cumulative fixed deposit is where the depositor is allowed to withdraw the interest amount at the end of each quarter, and the Principal amount is repaid at the end of the tenure of the deposit.   In this type of deposit, the Bank will pay compound rate of interest, but the amount of interest itself would be less than that paid on deposit where interest amount is not withdrawn in between.   Because of the reason that here, the interest amount is not being ploughed back into the deposit.  This particular type of deposit is suitable for people that need a regular income periodically, and not necessarily every month.

As a customer, please do study your requirements, and if necessary, consult your Banker, before deciding upon the type of deposit that suits your requirements.

THE GREAT INTEREST RATE SLIDE

Falling!   Falling!   Falling!   Interest Rates!   They are a falling.   And how?!   From the United States to India and in Britain, in between, interest rates have been sliding as never before in history.

The rationale for the frequent cuts in the interest rates is, among other things, to make credit more affordable to individuals and corporations, with the expectation of increase in the offtake of credit, and also to create a set of new borrowers!

Central Bankers around the world seem to think that reducing interest rates would do the trick of increasing public lending.   Rather simplistic, one might argue.   Because, public lending operations are carried out by Commercial Banks that are obliged to adhere to certain norms in their lending operations.   Non adherence to these norms can not only jeopardise the loan asset, but also get them into trouble with the Regulators, the Central Banks themselves.   That apart, they (commercial banks) would be doing a disservice to their depositor customers by violating sound lending norms.   In fact, the current banking crisis in the West is, in large measure, a result of non-compliance of sound banking principles and the lending norms.

What does a Commercial Banker look for in a potential borrower?   Among other things, the borrower’s eligibility for the loan requested by him, and his capacity to repay the loan, alongwith interest in the stipulated time.  

Reducing interest rates might increase the demand for loans, but a lending decision hinges on the borrower’s financial health.   To the extent that reduction in interest rates contributes to the increase in the number of eligible borrowers (those that qualify for a loan, and have the capacity to repay the same), interest rate reduction would have served its purpose.   But is that really the case?   A simple increase in the number of people lining up before the Banks for a loan is not sufficient indication of the success of the interest rate reduction formula.

The key to increasing lending, not only to corporate borrowers but also to the retail segment, is the increase in the demand for loans from quality borrowers, and not just an increase in the supply of money available for lending.   That is the crux of the matter.   Whereas Central Banks may have control over the levers that enable them to increase the money supply, and thereby the demand for loans, they do not have control over the supply of quality borrowers.   That depends on the overall economic situation, especially the job situation.

The current job scene as it is now, with layoffs, freeze on new hiring, business failures across sectors, etc., becoming a daily occurance, the number of quality borrowers, would, in fact, tend to come down.   How then would you expect the commercial  banks to lend more?   And to who?   Must the banks lend to second and third rate borrowers and risk the health of the institution, apart from earning the wrath of the regulators?   That is the million dollar question.   It also underlines the limitations of the Central Banks in living up to the expectations of the political establishment, as well as the general public.

The coming months may see a war of sorts between the Central Banks and the Commercial Banks, each blaming the other for not doing enough to alleviate the pains of the current economic crisis.   The truth of the matter is that this crisis is a result of faulty policies  pursued over a long period of time, and can neither be wished away, nor easily resolved.

It may be some time before the crisis plays out its course, and normalcy is restored.   How long a time would that be?   Does anyone know?

Views expressed above are personal.

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