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It was October 2000. The start-up I had co-founded six months ago was in trouble. The original plan to become an online Direct Selling Agent (DSA) for car loans (clients compared and chose from competitive online car loan quotations) had not worked as anticipated. We were forced to pivot the model and become online DSAs for credit cards. This took off well and helped the start-up survive.
While I understood why credit cards were popular among individuals, I always wondered why shopkeepers accepted them. If a customer bought goods worth Rs 1,000 and paid in cash, the shopkeeper received the entire amount immediately. But if the customer used a credit card, the shopkeeper only received Rs 990, and that, too, after a delay. My banking friends explained that data proved people shopped for more (or bought upgraded versions that were more profitable) when paying through a credit card. This increase in sales (and profitability) more than made up for the 1 per cent commission the shopkeeper paid to the bank.
This 90-second video by behavioural economist Dan Ariely (https://vimeo.com/62116854) brilliantly explains how credit cards
promote instant gratification, and lead to over-purchase by artificially expanding the money available and by removing the “pain of paying”.
This also accounts for the stupendous popularity of “Buy Now Pay Later” (BNPL) credit products. Replacing the full purchase price with a much lower monthly instalment appeals to the buyer’s “instant gratification” buttons.
Unsecured loans are growing at an explosive rate currently. India’s savings rate on a net basis (that is, savings minus borrowings) has touched a 40-year low. For the first time ever, households are borrowing more than they are saving through bank deposits. On March 31, 2023, banks’ personal loans outstanding (made to households) stood at Rs 40 trillion, for the first time surpassing the amount (Rs 33 trillion) lent to industry (this data is from a Marcellus Investment Managers blog). The rapid growth in unsecured loans has led to the Reserve Bank of India cautioning “banks to strengthen their internal surveillance systems, watch the trends, and take whatever measures are required”.
Those over-borrowing through unsecured loans are essentially pre-empting their future incomes to pay for today’s consumption. Yet, loans are not always bad. Very few citizens would be able to buy their own homes, cars or two-wheelers if they did not take a loan.
While advising clients, we use the Double A framework to distinguish between good and not-so-good loans.
Good loans should ‘add’ to assets or income and be ‘appropriate’. Home loans add to assets while an education loan adds to income-earning capability. But both need to be appropriate. A household earning Rs 1 lakh per month should not take a loan to buy a home that costs Rs 1 crore, as it is well beyond their repayment capability. Home, education, two-wheeler and car loans of appropriate value add to an individual’s assets or earning capacity and have a multiplier effect on the economy.
Truth be told, resisting the allure of an easily available unsecured loan, which satisfies the need for instant gratification, is difficult. Yet, practising delayed gratification, even if the delay is only for a few months, can be rewarding. I recommend a Pay Now, Buy Later (PNBL) plan. If an item costs Rs 12,000 and is not immediately affordable, then instead of taking a loan, start investing Rs 4,000 per month for the next three months (or Rs 2,000 for the next six months) and buy the item after redeeming the investments. The anticipation before the purchase and the pleasure of doing so from your own resources will result in a manifold increase in enjoyment. Sometimes, the introduction of the “pain of paying” and the delay before the purchase may make you realise that you don’t really wish for it.
In that case, you can have the pleasure of using the money for a more worthy item or for long-term purposes. Delayed gratification has its own rewards.
The writer heads Fee-Only Investment Advisors LLP, a Sebi-registered investment advisor;
Disclaimer: These are personal views of the writer. They do not necessarily reflect the opinion of www.business-standard.com or the Business Standard newspaper
(A slightly different version of this column first appeared in the Business Standard on November 06, 2023)