The Loan Melas Conundrum- Explained, pointwise

Introduction

Union Finance Minister recently asked public sector banks (PSBs) to give credit through outreach programs in every district of the county and referred to the 2019 “loan melas” undertaken by banks across 400 districts.

The finance minister first pushed lenders(PSBs) to reach out to customers and signal their willingness to lend during the festive season in September 2019. That year, the loan melas were conducted in October across 250 districts to make credit easily available during the festive season.

However, it is not the only way through which the government is pushing banks to provide cheap credit in bulk. Previously, similar attempts have been made through Differential Rate of Interest (DRI) and MUDRA loans.

What is a loan mela?

Under a loan mela, cheap credit is provided to retail and small businesses during a festive season.

The idea of popularising cheap credit started in 1972 after Indira Gandhi’s Differential Rate of Interest (DRI) scheme, which made banks allocate at least 1 percent of loans to farmers and weaker sections of society at highly subsidized interest rates.

The move faced intense criticism for diluting loan procedures and denting credit culture.

What is the rationale behind loan melas?

Presently, the overall demand in the economy is still weak. A weak demand results in a weaker consumption scenario. Hence, a higher flow of credit to various segments of the economy will help push consumption and investment, thereby accelerating economic recovery.

The point of the loan melas is to link villagers directly with banks, to boost rural spending. Thereby, it will boost rural consumption-led economic growth.

Furthermore, Loan melas result in a positive influence in forcing banks to focus on under-banked areas. This gives a push for financial inclusion.

What are some issues/concerns associated with loan melas or cheap loans?

There are multiple issues/concerns associated with this concept.

Huge bad loans: Even in the 80s, when loan melas were conducted for the first time, it led to the creation of huge bad loans for the banks. Presently, when PSBs are already suffering from NPAs, giving away cheap credit can further worsen the problem.

Pressure on the banks:  The state-run banks who would want to be in the good books of government will be under tremendous pressure to show these melas a success. The objective of managers in PSBs shifts from quality to meeting lending targets. This affects the overall asset quality and lending capacity of PSBs.

Lack of a robust recovery mechanism: Once the loan is given, there is virtually no effective mechanism that can be employed to get the repayment. Banks have recovery agents and business correspondents, but often they are local people and the borrowers don’t take them seriously.

Consumer demand: consumers are also not keen to borrow at the moment. The decline in income because of Covid-related disruption and the given medium-term economic uncertainty is unlikely to encourage households to accumulate more debt. Thus, pushing more credit in encouraging production will not be feasible when consumer demand is dismal.

Lessons from MUDRA: Something very similar to loan melas was done through MUDRA scheme. Under this scheme, collateral-free or unsecured loans of up to ₹10 lakh were extended to micro and tiny businesses. As per a report, NPAs under the scheme that stood at Rs 384 crore at the end of December 2018, rose to Rs 516 crore by March 2019. Thereafter, it rose to Rs 530 crore by end of March 2020.

What are the measures that can be taken?

Let banks decide on credit deployment: Areas in which banks choose to deploy credit is a commercial decision determined by the demand for loans and best left to the banks.

Rural and small business finance network: There is a need for a ‘rural and small business finance network’ that could be a repository of information and data on the wide variety of rural financial markets. It could use emerging technologies in the realm of customer profiling, assessment and evaluation, and track progress and performance. This information should be accessible to institutions and governments for periodic review and program development.

Products catering to rural and semi-urban areas: There’s a need to develop products and services that could harness the potential in rural and semi-urban areas. The need for products with features of safety and stability along with scope for generating strong and sustainable investments is what is essential.

Sources: Livemint, Business Standard 1, Business Standard 2, India Today