What is the world’s largest prime number? Just kidding…this isn’t an article about math!

This is about RW Emerson’s quote: “Money often costs too much”; this is about the impact of the prime-lending rate (PLR) on the common man and its far-reaching consequences on the economic future of the country. To put it simply, this “prime” number is the interest rate that the central bank would charge for a loan that it lends to say, one of the banks.

Though the prime is an index measured in basis points, it’s a metric decided upon by the powers that manage the central bank, and it is adjusted every once so often. Barring economic casualties that seem to arise often of late, there is a specific schedule to evaluating and adjusting this rate.

There are various factors that go into how this rate is determined, and how it is altered, but that’s beyond the scope of this short article. When looked at a consumer’s perspective, the prime rate determines how the banks that deal with individuals (the ICICI’s and SBI’s of the country) go about lending money.

For example, if a private bank is aggressive at handing out loans, these loans might be offered to the customer at prime rate or just above it, with a marginal profit. This is where it all gets interesting – the banks in India currently don’t seem to distinguish between the individuals’ ability to pay off the loans and their past history at doing so, when doling out loans.

Of course, there is the lien that people need to provide and records of assets owned, etc to back up claims for loans at the higher priced housing levels, like those seen in the millions of rupees range. At certain lower levels like automobile loans or consumer purchases in the lower hundreds-of-thousands, there seems to be a near free-for-all eligibility to get hands on one of these loans.

There’s a very thin line that divides the consumers’ desire to upgrade their lifestyles with borrowed money and, to put it simply, the greed to not be able to distinguish between wants and needs depending on affordability.  The US economy, beginning with the sub-prime housing crisis, and now extending to credit difficulties caused by very poor liquidity at all levels imaginable, should be an important lesson for India.

As the saying goes, it is best to learn from the mistakes of others, and not repeat it oneself. The law makers need to encourage good, responsible behavior while at the same time make it difficult for people to stretch their economic freedom to levels where they can no longer sustain it. I am sure there are conflicting opinions between achieving rapid economic growth vs. sustained growth at slightly lower levels, by controlling credit, but this balance might be important to ensure the long-term health of the economy. This is where utilizing the “power of the prime” to ensure adequate liquidity levels becomes very important.

Unlike some of the developed Western economies, India doesn’t (yet) have a centrally reported “credit score” for every individual. To establish such a system, there needs to be a central database that pretty much tracks the “credit history” of every individual. This would mean tracking all transactions wherein there is not cash or an instant money transfer (debit purchases) involved. In other words, transactions that require borrowing of money would need to be reported by all the banks that offer credit cards or loans, to the central reporting / monitoring agency. This bipartisan agency would then come up with a ’score’ for every single individual based on his / her past record with loans and promptness in paying off debt. I hope this system is included as part of the e-governance transformation the country is undergoing.

Given a transparent setup that everyone has access to, the lending institutions wouldn’t fall over one another in doling out sub-prime loans (and then have people head over heels in paying off these loans), and banks would really understand the risks behind each loan made. This results in accountability getting built into the system at all levels.

More importantly, it is never too late to reward good behavior!

Image Credit: Woodley Wonderworks

Popularity: 12%

Whole world is reeling under economic crisis. Growth rate of countries is slowing down. While some sectors have lost heavily, other sectors have revised their targets. Amidst all this turmoil, there is one industry that is making profits and guess what this could be?

It’s the epicenter of the financial tsunami-It’s the banking industry… The very cause of the turmoil in the world is now making money in India.

Is it the strict regulation of RBI or the traditional way of running the business that has helped the banks to be in profit ? Or is it the foresight of Indian banking system that has ensured that domestic banks are not heavily exposed to the credit derivatives like US banks ? The fact is that the Indian banks have not incurred huge losses unlike their counterparts in the US and rest of the world.

Banks which faced pressure on their margins till a couple of months back are now on their way to making money. With the RBI’s initiative to increase liquidity in the system, banks got huge amounts at their disposal for lending. Even the money that was lying with RBI and yielded very little profit is now available for banks for lending at higher rates. Banks are lending at higher than PLR to corporates due to the changes in circumstances and all these are helping banks to boost their bottom line.

Quite a few factors have contributed to the profit margin of banks:

1. Reserve Bank of India has cut CRR by 3.5 % and brought it down to 5.5%
2. It has cut the repo rate by 1.5 % and got it to 7.5%
3. RBI cut the SLR by 1% and got it to 24%.
4. Banks used to lend to companies at below BPLR but now they are lending at higher than BPLR as the risk profile has increased due to the hit on the margins of the companies.
5. Banks used to shell higher deposit rates. But with the markets falling, people are finding deposits as a safe place to park their money and banks have cut down the deposit rate.

All these have increased the profit margin of the banks by 3%.

While all sectors of the economy are facing the heat of economic meltdown, it is surprising to see that our domestic banks are really making money.

Banking in India has been indeed a blessing in disguise. What do you think ?

Popularity: 20%