Wednesday, April 19, 2017

Catastrophe of bank interest rates – 8

Continued from the previous post –

Now we shall see behavior of different borrowers.
Manufacturers – this category demands large sum of money to do their manufacturing activity. Loan money used to buy raw material and to pay for other expenses. Repeat cycles in this category are not same for all products and depend largely on the product. Number of cycles could be small. Profit margin is of the order of 60% to 100%. This large profit margin covers for the less numbers of repeat cycles. In consumable goods, repeat cycles could be very good and so at this rate of profit margin higher rate of interest on loan could be acceptable to most manufacturers.
If you study balance sheets of many manufacturers, you will see that out of total expenditure only about 4 to 7 % is spent on interest on loans that company has taken. Business management in manufacturer's category and shoppers is more or less similar and high interest rates (15%) these borrowers can easily manage. Some loans are for expansions in business and that being capital investment higher rates on their loans should be accepted by them. Many companies in India have developed with this rate of interest and grown to monster sizes. This observation clearly rules out, any need for reduction in interest rate to this category. When it comes to profit sharing on their product since, they have done business from borrowed money, which belongs to depositors; appropriate share of that profit must go to them in the form of higher interest rates on deposits. These depositors are actually silent sleeping partners in their business and so their right to profit cannot be ruled out. If business does not work well on whatever account since they are silent sleeping partners they need not suffer from that loss. Losses most of the time are due to mismanagement of the business so, depositors cannot be punished for that. Banks are entitled to recover their dues even from losing borrower by law. Mr. Rajan ex-governor of RBI had voiced grievances of depositors but as he showed sympathy Modi government sacked him. This shows how dangerously the gambler group is working against depositors. Efficiency of an industry can be judged from its expenditure on interest on borrowings. An efficient industry does not spend more than 4 to 7% on bank interest. Any rise in that expenditure means industry in not functioning at its best. Squandering of funds, misjudgment on supply and demand consideration increases this burden. These mismanaged industries often favor lowest interest rates so that they can continue their mismanaged behavior. To stop this squandering of funds on concerned and unconcerned topics we can stop by putting an additional levy if bank interest component exceeds 7%. This provision may help control such indiscipline. Industries can be rated as green, yellow and red based on its efficiency. Green for best management, yellow for medium and red for bad management should be the rating.

Continues in next post –

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