Beware: Sellers' schemes in the money marketplace are often self serving
Posted by: Uma Shashikant on Jun 19, 2017, 06.30 AM IST
By Uma Shashikant
A little crowd gathered at the entrance to the railway colony, mostly made up of young boys and a few girls. The others stood at the main door of their homes or hung on to window sills in eager expectation.
Then the much-awaited scooter rolled in. Everyone cheered and clapped. Children ran behind the scooter as its proud owner drove it slowly to his door, where a little ceremony was performed and sweets distributed to the crowds. Such was the drama that played out in the 1970s when it took years for a scooter to be delivered.
As we recollected this and the many other stories of our childhood at a recent reunion, I could not help wonder how oblivious we as consumers are, to the cash flow plays of businesses. The advance that scooter companies got from eager buyers willing to wait for years provided enough cheap capital to the business. So much so that it was easy to deploy these advances to long-term uses, or even park them in the inter-corporate deposit market for a good interest income.
Though scooters are now available off the shelf, the various forms in which businesses raise easy money from the public has not changed. Real estate businesses are at the top of that scale of sharp mobilisation of interest-free money from home buyers. They nonchalantly put such advances to other use, expanding into more projects, even as they delay the housing project that had been sold for a hefty advance.
There are several clever ways in which housing projects are packaged, only to ensure that we commit to a purchase and pay up an advance. The gifts, cash backs, EMI waiver and every other scheme that comes with the offer for sale, is nothing but a clever wrapping of costs the borrower is willing to incur, so that we commit to paying for the house. Then there are the gold saving schemes.
These are nothing but clever ploys to get cheap working capital from buyers, who are lured by concessions that are offered with the deposit schemes. The cost of these gifts and concessions is usually much lower than the cost at which these businesses would raise capital from other formal sources.
Not many of us pause to ask how a zero interest consumer loan is even possible. We do not add up processing charges and fees, the mark up of prices of the goods being bought, the concessions and discounts foregone, or the advance instalments that are paid. We are willing to simply accept an aggregated sum as the price and if the instalments add up to this number, we believe we have gotten ourselves an instalment scheme that carries no interest. Our naïveté with respect to businesses around us extends to impulsive purchases we make when there are discounts and mark downs.
Or when the neighbourhood shop offers us credit for groceries we buy. These businesses incur a steep cost on rent and space. When goods sit on their shelves, they incur further working capital costs to fund the inventory that they are holding. It is important for them to convert that stock into cash, and achieve a faster turnover of inventory.
While we think we have gotten ourselves a good 'deal', those businesses are relieved that idle stocks have cleared up. We mix up the math even in financial products. An insurance product that collects premium from us today in return for a payout sometime far into the future, sells easily because we compare the premium payable with the benefits receivable, completely ignoring the time lapse between the two events. If we paid Rs 5 lakh in premium in the next five years, and received Rs 10 lakh as benefit after 20 years, we actually get a poor single digit return that won’t even compensate us for the inflation. It is not as if businesses are out to fleece us.
A running business is constantly in search of capital and will make all effort to raise it as cheaply as possible. A formal institutional market for lending and borrowing exists, which is primarily made up of companies, banks and finance companies. The rates in these markets is competitively determined. If a business finds it easier and cheaper to raise money from the public, it chooses to use that as an additional source of capital.
A bank, for example, would raise money from the public at far lower rates, through deposits, by offering facilities and services. If it raised similar amounts from the institutional money markets, it would pay a higher rates for interest. A company seeking a loan from a bank can negotiate a lower rate of interest, as compared to an individual loan seeker.
As home loan seekers we do not have access or acceptance with lenders in the marketplace. Nor can we issue bonds to raise capital. We may be unwilling to release our income tax returns in public to prove our repayment capability. That is why we settle for a higher cost home loan from the bank, and agree to pay an interest rate that is higher than what a company borrowing from the same bank would pay.
The bank in turn, structures the home loan in alignment with my repayment abilities. It does not ask us to return the loan in a lump sum. We would have to sell the house to do that! Instead it structures the repayment in EMIs so that we accept a higher effective interest rate as the price for the convenience of easy repayment.
The marketplace for money is about such transactions, where lenders and borrowers work out schemes that will optimise for their need and the preference of the other party. Over time, players will settle down to operating schemes, products and plays that benefit their balance sheets.
As savers and consumers, we fund a good part of this machine. Sometimes we suspect the seller of exploitation; sometimes we give up some benefits for the convenience; sometimes we settle for a steep cost for instant gratification. The only emotion to avoid is the benevolence we wrongly attribute to a market player. Usually no one does anyone a favour or perform acts of love and generosity.
The cheering of the scooter was a case of mistaken celebration in an era of scarcity, where delayed deliveries against advance payments was willingly accepted. In modern times, such misplaced veneration is reserved for sellers of property.
(The author is Chairperson, Centre for Investment Education and Learning.) This article appeared in Economic Times dated Jun 19, 2017, 06.30 AM IST