Good intentions -Not so good results

[sajiv]

Generations of Indians have gone through the poverty cycle. Poor parents who cannot afford to educate their children and who remain illiterate or at best semi literate, are forced to do manual labour. They remain poor and in turn their children are also unable to educate their children and so on the vicious cycle of poverty continues. Even the poorest Indian realizes that the best way out of this cycle of poverty is to somehow get their children educated so that they can break out of this cycle.


Hence it is quite likely that each one of us will be aware of at least one example of parents doing menial jobs saving and scrimping (and borrowing at exorbitant rates of interest) to educate their children. These children then pull their families into regular middle class existence in a single decade after finishing their education. That is the power of education as a poverty reducing tool.

Recognizing this potential of education as a poverty breaking tool, successive governments have accorded high priority to the education sector. Higher education is heavily subsidized by the government. Education loans are part of priority sector lending for banks. Also to ensure that the loans are given at a reasonable rate RBI/Government requires that all loans classified as Education loans be priced at not more than 1% above their PLR.


One would have thought that education loan disbursements would be booming given the sky high demand for education loans combined with the fact that the implementation of these policies is not through a government body but through commercial banks which are reasonably efficient and mostly corruption free. But facts on the grounds are completely contrary. The total incremental education loan disbursements made by the entire banking sector for the year 2006-07 is around Rs. 2,500 crores which is quite negligible considering the bank's total deposit base. Compare this with the estimated unsecured loans (used primarily for consumption expenditure such as medical expenses, holidays, jewellery or business) disbursement of Rs. 20,000 crores for the same period and the contrast is very clear.

So what is the reason for this dismal state of affairs? Ironically it is the good intentions of the policy makers without offering any institutional back up that has resulted in this low penetration.

Given the long waiting periods for an education loan to be repaid it is correctly seen as a riskier loan. As the pricing of the loan is capped by regulatory fiat the banks naturally pick and choose only those loans that they consider completely safe (backed by security and for well recognized streams such as engineering or medicine). Also education loans though part of the priority sector, have no separate allocation. Thus banks like to do the other kind of loans (loans to small transport operators, professionals etc.) which they consider less risky and do just the minimum amount of education loans that they can hope to get away with. In fact, the private sector banks and foreign banks have completely kept away from the sector. Hence, the ironical result-the regulatory fiat to make the education loans less expensive has in fact resulted in very few education loans actually being disbursed.

The other big issue with the current structure of the education loan industry is the fact that unlike other loans most consumers require complete moratorium during the tenure of the course (moratorium is banker speak for not requiring the consumer to pay any interest or principal during the course period; instead the interest accumulates during the course period and the repayment of the loan plus the accumulated interest begins after the course is complete). This consumer requirement is quite logical. For most students (and their families) they cannot really afford the course expenses and are hoping to pay off the loan from the earnings that the student will be able to get after completing the course.

(In fact, for people doing a professional course mid career the requirement of loan is not only for the course expenses but also for the living expenses of his/her dependents during the course period where the student is the main wage earner which is another story)

Given that the average course duration is around 3-4 years this means that the lender has no idea during that period whether the repayment on the loan will be on time or not. Hence their options for re-financing this loan (getting funds from their lenders against the security of this loan) are rather limited and if available, likely to be expensive.

In most countries the government steps in to provide funding for such loans to the banks (who lend them to actual students with their margin) so that this essential sector does not wither away. Also there is institutional data available on various courses so that the risks of funding such courses can be evaluated separately from the risk of the student defaulting even after completing the course. Establishing such an institution would be of great help in kick starting the moribund education loan sector.

The other big requirement off course is availability of re-finance for the lenders. The finance minister in his budget speech in 2005 had promised to set up an education refinance corporation from part of the education cess that all of us pay as surcharge on all our taxes. This promise has still not been fulfilled and one hopes that with the elections due next year we will see some action on this front, if only to score some brownie points in TV debates and speeches.

In fact given the large latent demand for education loans entrepreneurs are already scenting a big opportunity in this sector and a few companies have already made plans to enter this sector.


One such company is Credila Financial Services floated by the Bohora group with reported equity participation by DSP Merill Lynch. It has already starting disbursing education loans. One area that they are able to clearly differentiate is in providing loans for courses that will not be approved by the PSU banks that tend to fund only courses that are approved by UGC. Also given their private sector nature the operational formalities may be easier (only the future can tell that).

But given the complete absence of re-finance they (and other companies like them) will have to necessarily concentrate on students whose families have some financial backing at least to repay the loan. Also it is unlikely that they will be able to offer moratorium on interest during the course tenure. Thus, only the relatively well off students will be able to benefit. Don't get me wrong. This will still be a great first step but in the absence of supporting infrastructure they will only make a small mark on this rather large canvas.