Every Indian Businessman’s Wish: Lower Interest Rates… Possible?

Jun 20, 2020

PM Narendra Modi inspires the country by giving them the dream of a “$5 trillion economy”. We, the ambitious and resilient citizens of the country feel that this is very much achievable. It’s ‘timing’ though might be up for some debate. But is there anything that could really just unleash the Indian Economy and propel it to a higher growth trajectory?

But let us start by addressing a Big Problem!!! We all hear about the ever-increasing NPAs in the banking industry. We jump the gun and blame all the businessmen for looting the ‘taxpayers’ money. We paint all of them with a single brush as the ‘big villains’ of society. Ironically, even people who have not done any business in their entire life or paid a single rupee of direct taxes have strong opinions on the subject. But seriously, are we really that naïve to think that all businessmen whose accounts turned bad were just the villains and not the victims themselves? So, the problem I was speaking about was not the menace of NPAs, it is the mindset problem of our society at large towards the business community.

I remember this conversation I had with one of my clients. He said, “The business environment in the country has changed over the years and there was no fun left in doing business. The government and the general society are indifferent to the pains of a businessman. Business nowadays is not lucrative enough to absorb any unforeseen shock. The biggest reason for the failures of most businesses in India is the ‘high cost of funds’. After paying off all the capital providers and stakeholders, very little is left on the table for us to survive and thrive. If lenders lend at a such high cost, businesses are bound to fail. So, the lenders are equally responsible for the NPAs.”

“LOWER INTEREST RATES” has always remained on the top of the ‘wish list’ of every businessman in India over the years…

But taking into consideration the overall development of Indian financial and capital markets, it leaves me pondering whether there is anything that could really change. Will the borrowing cost ever come down?

The cost of funds for a borrower can be broken down into three factors – (1) cost of processing the loan (2) Base cost of funds of the lender and (3) Spread/margin for the risk underwritten. Let us address these factors and try to find possible solutions that might help us to reach a lower interest rate regime.

1)    Cost of processing a loan proposal:

The processing fees a lender levy is towards the recovery of the time and efforts of its manpower involved in the processing of the loan and apportionment of the overall operational cost of the organisation. So, let us have a look at a few factors that can help lenders to reduce the upfront processing fees:

a)    Use of technology: Though we are living in the information age, the lenders in the country have been very slow in adapting to ‘technology’. As the lenders make better use of the technology, the lesser would be the human and infrastructure cost. Another benefit of lesser human intervention and discretions in the credit appraisal process.

b)    Economies of scale: One of the biggest achievements of the present government that has been largely underappreciated or underrated was the consolidation of the public sector banks. But personally, the sad part for me was when they over-emphasized there would be no loss of jobs in the consolidation process. Understandably, it might have been to accede to the demands of labour unions. But the synergies of the mega bank merger cannot be realized unless we rationalize the workforce. Can the government lure public sector banks with the promise of additional capital if they achieve operational efficiencies?

Only one Indian bank (namely State Bank of India) features in the list of the top 100 banks in the world. For the third biggest economy in the world (on a PPP basis), this is quite intriguing. Exploiting economies of scale is essential for any business but more so for a bank. We need fewer banks and bigger banks. We need even more consolidation in the banking industry. Can we request Mr Uday Kotak take over Axis Bank instead of forcing him to reduce his stake in his bank?

 2)    Base cost of funds of the lender

The base cost of funds of a lender is to provide for the cost of its liabilities (demand and time deposits) and shareholders’ funds. This forms the major part of the cost of borrowing. What can be done here?

a)    Reducing the cost of liabilities: For any request for reducing the cost of funds, the lenders would be quick to tell you that their own cost of funds is very high. How do you expect the interest rates to be lowered when the banks are themselves paying 5.00-7.00% on fixed deposits? And if we explore further as to why they pay such high interest on fixed deposits, the revert would be even quicker – many citizens, especially senior citizens depend on the interest income on these fixed deposits for their livelihood. With the underdeveloped social security systems of the country, it’s hard to counter-argue. But no interest on savings accounts and very low-interest fixed deposits just to meet inflation (probably other than for senior citizens) is worth exploring. The government can also afford to bring the senior citizens under some health insurance schemes like ‘Ayushman Bharat’. This might work for the ‘vote bank’ politics as well.

b)    Reducing the tax rates on banks/financial institutions: The banks typically pay income tax at the highest slab rates. Considering that banks/financial institutions are the backbones of any economy, the rates of taxation should be kept at a minimum level. If we can offer new manufacturing units attractive tax rates of 15%, then why not banks and financial institutions? They have to play an equal role in reviving the economy and spurring growth. This benefit will be passed on eventually, as the market dynamics usually play their part. This tax incentive will play a big role in developing the banking and finance sector which is quintessential for any economy to grow. It may attract foreign investment as well which is very much required in this sector.

3)    Spread/margin for the risk underwritten:

The banks/financial institutions need to be rewarded appropriately for the underwriting risk in the lending business. This is directly proportionate to the state of the economy and industries. The risk of default or the evil NPAs as you know better. Lets us assume in all good faith that a small portion of this menace might be automatically resolved with a lower cost of funds making many businesses viable that were otherwise not.

a)    Better resolution and disposal of the NPAs: We need a resolution framework that is so robust that lenders can easily dispose of the securities in the case of NPA accounts. The mechanism of the SARFAESI (Securitisation and Reconstruction of Financial Assets and Enforcement of Securities Interest) Act and the (IBC) Insolvency and Bankruptcy Code need to work so seamlessly and efficiently that lenders get the required confidence. Presently, the IBC Code is only applicable to companies and limited liability partnerships. Its scope should be expanded to cover firms, individuals and other entity forms. As a society, we should also remove the stigma around ‘bankruptcy’ or ‘insolvency’. In business, you assume risks, sometimes they work and sometimes they don’t. Let us learn from the fact that the businesses of the present POTUS – Mr Donald Trump declared bankruptcy six times between 1991 and 2009.

b)    Liberal prudential norms from the Reserve Bank of India: With my little experience in the banking and finance industry, I have realized that lot of NPAs could be avoided if we have liberal restructuring and takeover norms. If we want to compete with China, the banks/financial institutions need to be more accommodating to our businesses. The policies should be drafted to facilitate business and not strangulate them.

I know that I am oversimplifying the possible solutions to the problems. But our businessmen need someone to really care and think about them.

If we aspire for our companies to remain competitive in the global markets, if we want our industry to create more employment and if want businesses to pay more taxes to enable the government to carry on its social agenda, businessmen need their problems to be addressed. Let us start the deliberations somewhere.

I welcome your thoughts and insights.

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