Mr.Seagrass is an Entrepreuner and a post – graduate. He started a small scale manufacturing business and has run it profitably for several years now. His business is primarily funded by a MSME loan from a state owned bank.
The bank has sold Mr.Seagrass one of its prime product – A loan. The price it expects for this loan is the Principle plus an interest. It effectively asks Mr.Seagrass to repay almost twice the amount it lent him. Mr.Seagrass has to do this irrespective of his business succeeding or failing.
If Mr. Seagrass fails to replay the loan, he loses his initial investment of 25%, the mortgaged asset, and loses the capability to start any other venture in the near future.
In terms of Monetary value, if Mr. Seagrass has got a loan amount of 25 lakhs, he would normally invest around 23 lakhs in Land, building, machinery. His working capital would be roughly around 2 to 3 lakhs. This amount will be invested in his business every month, or at the start of every production cycle. This 2 lakhs rupees will be converted into finished goods; the value of which should be (Monthly principal repayment of Rs.25,000 + Interest of Rs. 35,000 + Working capital of Rs. 2 lakhs + profit of Rs. 20,000). Total Monthly income needed should approximately Rs. 2, 80,000.
If this income drops, Mr.Seagrass will be unable to pay the Monthly EMI, or will have to reduce his working capital / production capacity for the next month, or reduce the profit which will make him vulnerable to raising raw material costs / labor wages etc. A drop in income below the needed amount will compel him to choose between – Faulting on bank repayments, OR – Impacting his business and productivity.
To protect their business from landing into this scenario, many successful businessmen in India have very excessive profit margins. In the long term, it is this practice which contributes to the fast raising inflation.
Many other businessmen take the route of tax evasions, money laundering, etc. This protects them and their business, but is a legal crime. It leaves deep wounds on the country’s economy.
Road Ahead:
Loans and repayment structures should be designed to help the bank, the businessman, and the country. Aim of any business to succeed should be correct focus during the initial formative years. If focus is on doubling the bank’s money, business succeeding will be a dream.
One practical and effective way for designing loans is to calculate EMI for the current month’s principal repayment amount and not the whole loan amount.
This will necessitate the businessman to pay interest for every month’s Principal repayment. The current month’s principal repayment is the money he owns to the bank for that month, and it is logical to levy interest on this amount.
Consider a Recurring Deposit, interest earned is on the amount deposited till date, and not on the whole RD amount during maturity. Is not this the practical and sensible way to design interest payments?
Mortgage Dilemma:
It is also worth noting that in addition to the Monthly EMI, the bank also has a mortgage from the borrower. The standard in India is Mortage asset value should be more than 50% of the loan amount.
Mr.Seagrass has mortgaged his industry’s land to the bank, and in addition pays a monthly EMI. Now he has to drive his business, exploit his laborers, increase his profit margins and do everything else it takes to pay bank the monthly EMI. If not, he stands at risk of losing his land, and the business infrastructure he has built up. His hands are tied till the time he repays the bank loan and releases his mortgage.
Mr.Seagrass has invested 25% of his loan amount as initial investment from his personal funds. He also pays monthly EMIs. In case of a failure to do this at any point of time, he stands to lose both the amounts. In addition he also loses his mortgaged asset. How about a sudden electricity crisis in the state, or a financial recession in the country, or raw material shortage, etc.. the businessman loses the money he has invested ad paid till date and his assets, and also the confidence to ever start a business again!
Should not mortgage’s be levied on defaulting borrowers? Instead it is made a mandatory for the loan application, thus tying the hands of the borrower.
End Result:
Bank’s are satisfied that they have taken all measures to minimize defaulters, and save Bank’s money. But the Business man is made to take the risk, instead of the Bank. The risk factor has just been pushed to the business man.
The Businessman, to save his business and earnings, makes sure he levies high profits, increases his product selling price, exploits labourers by paying the less and demanding more work, evades tax, does out of bank transactions and launder’s money, etc. He has effectively pushed the risk from his shoulders to the country’s shoulders.
Eventually the country’s economy takes a beating. But not immediately. Growth rates improve, numbers and figures in statistical charts show upward trends etc. But in the long run of 5 year to 15 year period, the economy takes a beating.
It is wise to remember that the country’s economy is not a single person. It includes the banks, businessmen, laborers, and every single member of the society. So all of us would be taking our share of the beating eventually.
We, the people have to be aware that money in Bank’s comes from people. Banks use people’s money to keep the country’s economy healthy. Any small scale or large business is not only about profits.. but about sharing the profit in improving the country’s economy.
The economy takes a beating.., businesses close down rapidly, but banks continue lending money and earning interests. Money gets heaped in one place. Is this not a system failure. It calls for a re-design of banking system, and the country’s economy.
ThoughtlessWays 