Saving Credit.

Many a times it has been seen that the demand for bank credit is weak rather not very stable, even while we are likely to have enormous demand for it if investment picks up, banks have to go through the formal consensus and have to look upon the Indian banks own credit systems so as to ensure the capital ongoing and the entire inventory system of financial assistance. Unfortunately , on going through the data and consensus banks come onto a conclusion that India’s credit system is not in a good health. Banks need a fundamentally strong reforms which are able to change the mindset of consumers. A public lecture in the memory of a great Indian who did much to change our mindsets is a perfect place to make the case.

THE DEBT CONTRACT.

The flow of credit relies on the sanctity of the debt contract. A debt contract is now where a borrower, be it a small farmer or a promoter of a large petrochemical plant, raises money with the promise to repay with interest and principal to a specified contract or schedule. If in case the borrower is somehow not able to meet his commitment or promises, he is in a default. In the standard debt contract in case of any default the borrower has to make some substantial sacrifices, else he would have no incentives to repay. Now lets get into some history regarding this interesting topic. For instance , a defaulting banker in Barcelona in medieval times was given time to repay his debts, during which he was put on diet of bread and water. At the end if in case he was not able to pay he was beheaded.Punishments became less harsh over time. If you defaulted in Victorian England, you went to debtor’s prison. Today, the borrower typically only forfeits the assets that have been financed, and sometimes personal property too if he is not protected by limited liability, unless he has acted fraudulently. Why should the lender not share to the losses to the full extent? That is because he is not a full managing partner in the enterprise. In the return for not sharing large profits if the enterprise does well, the lender is absolved from sharing the losses when it does badly, to the extent possible. By agreeing to protect the lender from ‘downside’ risk , the borrower gets cheaper financing .

VIOLATING THE SPIRIT OF DEBT.

The problem which needs to be discussed is that the sanctity of the debt contract has been continuously eroded in India in recent years, not by the small borrower but by the large borrower. And this has to change if we are to get the banks to finance the enormous infrastructure needs and industrial growth that this country aims to attain. The reality is that too many large borrowers do not see the lender, typically a bank , as holding a senior debt claim that overrides all the claims when the borrower gets into trouble but as a holding a claim junior to the borrower’s own equity claim. The uneven sharing of risk and returns in enterprise , against all contractual norms established the world over where promoters have a class of ‘super’ equity which retains all the upsides in good times and very little of the downside in bad times, while creditors, typically public sector banks, hold ‘junior’ debt and get none of the fat returns in good times while absorbing much of the losses in the bad times.