A New Banking Policy: Prospects

A New Banking Policy: Prospects

By: Subhashini, Asstt. Editor-ICN 

NEW DELHI: Nelson Mandela, one of the greatest leaders in the world believed that no person can lead any effective social change without the advice, co-operation and criticism of others, even though he might be extraordinarily powerful or farsighted.

I am delighted to receive such an overwhelming response on my first post- “CONCEPT OF A NEW BANKING POLICY IN FAVOUR OF SMALL ENTREPRENEURS AND START-UPS” and I am thankful to all my viewers for putting forth their questions as well as their valuable suggestions. It is not possible to answer each one of them individually, so I have tried to incorporate most of them here. I hope you find my replies fulfilling. Apart from that, I have also covered additional aspects that needed more emphasis.

First of all, let us talk about the failure rate which I mentioned previously. The reason for considering the failure rate to be 0.05% was the concept behind my theory. Let’s discuss and scrutinize the intentions of start-ups and the reasons of failure with reference to the current banking policy and Red Tapism.

  • No entrepreneur starts his business without having a motive of durable profits.
  • Most of the times the entrepreneurs lack the prerequisite amount of research and market conditions required for the success and sustainment of a product or service.
  • They might overlook the technical aspects of the business structure.
  • They might invest on products which are not practically feasible according to the prevailing market conditions.
  • They wish to make products out of their own interest which in reality might have no demand.
  • There might be a lack of skilled workers, which might cause delay and a degraded quality of the manufactured products, which could affect the absorption of the finished goods in demanding market.
  • The entrepreneurs might not clearly know the way to recover from the losses they could face during the first phase of the business. They might commit mistakes while calculating ‘cost volume profit analysis’. (Break-even analysis)
  • Sometimes the start-up teams might not possess the aptitude to change the product (within the available facilities, framework and time period), or to research the new market conditions, or to rebrand the business, or even to wind up the business and restart again if required.

Apart from the above mentioned reasons, there are three major reasons behind the sky-high failure rate.

  1. Corruption

The most important factor that cannot be ignored is the corruption in the Government sector which creates so many unusual and deliberately imposed hindrances for the entrepreneurs at every step (as a result of working style of the License and Inspector Raj since independence) that they find arduous (as it is quite non productive and a wastage of time and money) to deal with. Eventually, they lose all their interest and passion.

Now I would be discussing the significant reforms and suggestions in my theory that could lessen the failure rate of start-ups and small entrepreneurs up to the level which I considered in my previous post:

  • There would be a privatised committee that would be formed under the Ministry and would have a panel of experts and consultants from the fields of Business Management, Market and Sales, Economics, Environment, Legal Experts, Science, Engineering and Technology, Agriculture, Small and Medium Enterprise (SME) Advising bodies, Labours’ Management bodies, Skilled and Non Skilled workers’ Management bodies, Chartered and Cost Accountants, Financial Analysts, and other people who are considered essential.
  • This committee would be paid through a special reserve that would be collected from the CSR funds of corporates in order to keep it unaffected from the Red-Tapism of the working of Government.
  • Every small scale and start-up project would be first scrutinised by this committee on the basis of the feasibility along with other relevant factors like pollution etc. This committee would check thoroughly and seriously each and every aspect of the project regarding its survival and future.
    The committee would be required to observe the following aspects in order to ensure the potential success of a start-up:
  1. To check whether an essential amount of technical research regarding the business structure, and the product or service has been done or not.
  2. To check whether the legal aspects and requirements have been covered or not.
  3. Whether or not there has been a careful study about the current and estimated future market trends needed for the success of their product or service.
  4. Whether or not the aspirant entrepreneurs possess the necessary education and qualifications required to set up a business.
  5. To inspect whether a particular product or service really in demand or at least capable of creating demand in future, or is it just because of his personal liking or whim.
  6. To inspect whether or not there is an availability of skilled and semi-skilled workers (as per the business requirement) in the specific area where the business is to be established.
  7. To check whether the break-even analysis and the gestation period is correct or not.
  8. To examine whether there’s any recognition of the possible problems that might crop up and a plausible strategy to overcome the losses that might be incurred after the onset of the business.
  9. To scrutinize whether or not there’s an alternative framework with vital research that could be put to use if required in order to start afresh.
  10. To advise the entrepreneurs regarding the necessary and essential amendments in their project report.
  • There should be an explicit law stating that no other department would be allowed to interfere or create any impediment in the smooth processing of the loan as well as the working of the business, once the committee has approved a project. Also, the banks would not have the power to deny sanctioning the loan to the entrepreneur once his project is considered feasible. This would help to restrain the corruption in a very systematic manner.
  1. Insufficient funds

It is known that the prime reason of failure of most of the start-ups is the lack of availability of required amount of funds. Let us try to understand the reality behind it. As soon as the business starts to grow and expand, there is an increase in the demand of funds. Most entrepreneurs are not able to catch up with the fast pace of their financial demands in the growing business. They run out of cash (insufficient working capital) and as a result their business suffers huge losses.

However, make no mistake while observing the fact that the increase in financial requirements (working capital) as the business expands in no way indicates that the business is sinking. This could possibly mean that the business is expanding in terms of area, infrastructure, capital etc and hence explains the requirement for additional funds.

Also, it is not necessary that in all the cases the entire provision behind a particular loan would be used up. In instances where the entrepreneur requires only a small amount of the working capital beyond the amount of his loan, he would be provided that amount from the provision and the balance would remain in bank’s provision fund and could be used in the future if needed.

  1. Psychological insecurity

Under the current policies, most of the entrepreneurs work with a psychological insecurity. They have a sense of fear that if their business goes down, their mortgage would be in risk and that might tear down their lives.If the banks adopt the policy which I have conceptualised in my earlier post, the chances of the survival of start-ups would increase more than one could imagine. (This is the essence of my idea, which could possibly lower down the failure rate from 60-65% to 0.05%. Hard to believe, but this could happen)

Consider a battle field. During the battle, a soldier fights with all his valour till he knows that his own battalion is behind him as a backup; and that if he is wounded, there are other soldiers to give him medical assistance and to take his place on the battle field immediately. Say, after a while the soldier realizes that he has no backup. Will he be able to fight with the same spirit? No. It is not really possible.

Similar is the case with small entrepreneurs and start-ups. One can understand the psychological insecurity they face in our current banking system. If my conceptualised theory is adopted, banks would be acting as a backup, and the entrepreneurs would have an assurance that banks would be ready to financially assist them if they fail, suffer losses, or require additional working capital for their business. The entrepreneurs would realize that their prospects of success have risen and would work without any meekness or a feeling of being insecure.

Additional aspects of the policy

When an entrepreneur runs a business, he provides employment to a number of other people, who would lose their jobs if his business fails. So as per my theory, if the bank is financially supporting the entrepreneur to run his business in his troubled times, it is also saving the employed people from losing their jobs.

The important point here is that the banks would not be experiencing any kind of an extra burden on themselves in maintaining the provision or sanctioning the loan to an entrepreneur the second or the third time, as his loan would be fully ensured. This is because the banks would already possess the provisions behind each loan which would be supplied to them by the Ministry of Finance; and the Ministry would obtain that money through the taxpayers and the general public; and that too, as a very small fraction of the taxpayers’ incomes (This wouldn’t be considered as a tax; instead, it would be a contribution by the general public for the growth of their country’s economy).

Consider the relationship of insurance to the life of a debt obligation. Say a business fails after 5 or 6 years. Would the insurance company still come forward to cover the risk? Yes, because the entrepreneur would be paying the premium to the insurance company each year until his loan has entirely been repaid to the bank. So that way, his loan would be covered for insurance for the entire time he takes to repay the whole loan amountIf the insurance company believes that their risk has increased many-fold by insuring such a large number of risky entrepreneurs, there would be a possibility of re insurance that the insurance company could go for if it wishes to. This could be done from those insurance companies that deal only with re-insurance.

Provisioning norms

My theory’s main focus is directed towards small entrepreneurs and start-ups, not towards the big business houses.  Observe that the provisions behind each loan under this policy would only be used for these entrepreneurs, and would not be relocated or used for any other kind of risk coverage. The central bank of the country should issue strict guidelines and a notification to all the banks stating that the transfer or utilization of these funds for any other category of risk coverage (or for any other financial purpose) in any case would strictly be prohibited.

Banks may continue to follow the Basel-III norms but my theory is different, as far as the risk coverage is concerned.

Now you might be under the impression that this money would become idle in case a large fraction of entrepreneurs achieve success in their first attempt. In order to ensure success of this policy, there should be a specified time period assigned for the working of this policy, say 20 or 25 years. If an entrepreneur who takes the loan from the bank doesn’t suffer losses, or fails entirely within this time period, the provision would not be available to him afterwards. Once a greater part of the businesses achieve success, you can imagine the amount of extra reserves in the provision funds which could be used by the Ministry of Finance for some other purpose directed towards the development of the country at a large scale, or to improve the status of the country at the world level.

This theory: Real or Ideal?

  • The Pradhan Mantri Jan Dhan Yojna, was initially criticised of being an idealistic policy; that it would need a proper functioning of the rural bank centres; and that the banks would not be co-operating with the Government, and many other speculations and criticisms. However it recorded a huge success at a very large scale once it was implemented, and as the statistics suggest, by 1st June 2016, over 22 crore bank accounts were opened and a total of Rs 38,411.80 crore was deposited under this scheme. Similarly, others might perceive this theory to be idealistic but I strongly believe that it would achieve success if implemented carefully.
  • The concept of insurance could also appear to be unrealistic and impractical. However, consider Pradhan Mantri Suraksha Bima Yojna and Pradhan Mantri jeevan Jyoti Bima Yojna; where the premium is only Rs. 12 and Rs. 330 per annum respectively for an insured sum of Rs. 2 lacs (Premium Percentage- 0.00006 and 0.00165 respectively). Insurance companies were able to earn a large amount of premium through such a small percentage. Now under my theory, if the insurance company charges 1% of the total loan amount as premium, one can estimate the money that the insurance company would earn. Hence, there is no reason for the insurance company to decline this theory.
  • As we know, all banks impose 2.5% of the loan amount as the loan processing charge. On the other hand, my theory suggests only 1% as insurance charge. Here, Government could request the banks to minimise their loan processing charges by 1% for the small entrepreneurs and start-ups. As a result, there would not be any extra burden on them in their first year. 

Conclusion

There is still a lot more to discover and expand in this theory. These questions will present a clear picture only once this theory is practically implemented. If the Government is unsure about the success of this policy, they should first implement it in a very small region of the country, and then decide for themselves. The basic idea behind this theory is to make every person self reliant, and to put an end to the problem of growing unemployment.

I agree that you might still find some intricate details missing in this theory, but if you look at the broader picture, this theory would be a huge start for the welfare of the country, which could be amended and reformed with time.

 

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