Economy & Finance

Rajaram Ajgaonkar
CA.

The Debt Trap

Money lending is one of the oldest businesses in the world. In the early days there were certain communities, which were considered to be specialized in money lending. They had means to lend, smartness to secure the lending and ability to recover the debt. Some of the communities, which have become well known for money lending are Jewish, Sindhis, Marwadis and Pathans. Though money lending was a service to the society, the atrocities of many of the lenders had made the service providers infamous. Islam considered money lending as a non-desirable practice. Historically money lending was unwanted; but was patronized by people as it was very helpful in an emergency. Many a moneylenders acted fraudulently due to greed causing a great disrespect and even hatred towards one of the most essential economic services.

The times have changed. The role of traditional moneylenders has been taken over by sophisticated bankers. They are very savvy, qualified and governed by rules and regulations. They make proper disclosures to the borrowers and all the terms and conditions are properly documented. They try to educate and give good service to the borrower. The type of atrocities which were faced by traditional borrowers from moneylenders has changed; but now new problems have emerged. There is sophistication in the system; but defaults by borrowers are rampant. The defaults lead to obvious painful actions of recovery, which always cause anxiety, loss of face and even unbearable stress for the borrower. This has resulted in extreme actions such as suicides and attempts to suicide by a few borrowers in distress. The primary cause of this extreme happening is greed and all the constituents should be blamed for the same.

As the banks are keen on doing more business aggressively, they are inducing people to borrow. As people and their families are keen to have all the luxuries and facilities in life without accumulating adequate savings, they are ready to borrow to the fullest extent of their estimated repayment capacities. When there is slight imbalance in the family budget due to some unforeseen circumstances such as sickness, arrival of guests etc., the whole family budget may get upset and the default may start. A default may start also due to loss of job or ill health of the bread earner. Once the default starts, the defaulter becomes liable to pay even high penal interest and charges such as check bouncing charges. The financially stretched borrower may not have adequate income or asset backing to fulfil his obligations though initially agreed. He further falls in the pit of larger liability, which can cause more miseries to him and his family. This can cause stress and trauma, which is mainly the effect of over leveraging one’s repayment capacity. It is essential for a borrower to calculate his repayment ability and also to look at his financial soundness to wither any unforeseen expenses before he borrows money, especially for consumption. There has to be an adequate contingency provided in the monthly budget by a borrower. If not, the debt trap is inevitable in many a cases.

It has to be understood by a borrower that today’s lenders are target driven. They are aggressive and are flushed with funds. If the borrower succumbs to their offer and borrows money, especially for consumption related spending, a situation may arise that he may not be able to repay his monthly installment. A borrower should not expect the lender to be soft with him in case of a default for a long period. The lender is not in the business to forego his money, and in case of a default, he is bound to exercise pressure on the borrower. To avoid pressures, trauma and loss of face caused by such situations, it is very essential that the borrowers live within their means. Loans are available now even without asking for. It must be understood that today, borrowing is easy; but repayment is not necessarily so.

In recent days, we have read a number of stories about the atrocities committed for recovery by various banks and their collection agents. They were criticized and were also subject to penalties for using excessive pressure on the borrowers. Considering the large number of borrowers which run into millions, such cases cannot be considered as a practice; but they can be only one of incidences. I believe that they are rare exceptions. If the Government exercises undue pressure on lender banks due to populist approach, the banking industry will suffer. It should be understood that money cannot be easily recovered by only sweet talks.

The boom in consumer lending has enormously helped Indian economy. Availability of easy loans and credit has increased consumer demand substantially, which has given a boost to Indian industries and even the service sector. If, due to the adverse publicity or unreasonable rules for collection process the consumer lending slows down, it can create substantial harm to Indian consumers, industry and thus to the economy. In rare cases of excessive use of pressure, proper action may be taken after appropriate investigation by the regulators. However, to treat the lender who follows up for collection of his money as a bad man, can be disastrous for the economy.

A consumer has to plan his affairs well before borrowing various types of bank loans or availing credit through credit card facilities. Typically, housing loans are long term, whereas consumer / personal loans are short term. The credit card credit is also a type of short term loan, which is needed to be paid in installments. A borrower needs to clearly understand that for a lender, consumer loans are expensive to administer and hard to recover. A borrower has to pay high interest cost to get such loans and the cost can be still higher in case of default. A borrower needs to calculate his post of tax minimum income for a month, reduce the monthly normal expenditure from the same and work out the net, which is his monthly savings. Only the savings can be considered for repayment of Equated Monthly Installments (EMIs) of loans to be taken. Further considering the contingency in expenditure, a borrower should not have liability of EMI, which is more than 60% of his savings. Contingent income such as bonus, incentive, etc. should not be counted while budgeting EMI, if they are not certain. A margin has to be kept for unexpected expenses, which are generally not budgeted. Such expenditure is bound to crop up in some or the other form, though it is uncertain as regards its timing. If the borrower is careful and can clearly calculate his repayment ability, risk of default can be reduced substantially.