Lending, Borrowing, Then and Now

Lending and Borrowing has been going on since history of mankind. It used to be Lender’s game earlier. In other words one who has capital always had upper hand in loan transactions and not the one who receive loan. In early days, on some very good reference + convincing business plan + some conditions (Interest rate 20%, timeline 1 Year) lender would lend money to Borrower say (10000 Rs). Borrower then uses that capital, adds his hard work, talent and performs business activity (Say starting a small workshop). With combination of capital and hard work he earns money say (15000 Rupees) and become successful. Now he has enough money that he can return principal + interest (12000 Rs after year 1). Money that he saves after returning what he owes to lender becomes his capital (3000 Rupees).

At end of day borrower used to be very much thankful to lender. In a country like India that young entrepreneur who received loan in his early days; would talk about lender and one who gave reference as “They are like god for me. They are the one who trusted me when I had nothing in my hand”. As time passed both lender and borrower became comfortable to transact with bank (Which I would define as big-brother between lender and borrower who reduce risks on both sides). But even while approaching bank, borrower had to provide viable project plan that would get questioned + guarantor who is responsible to pay loan back if lender fail to do so...................

Gone all those old days and somewhere in 2004-5 time, while working in office, I got call on office phone saying, “Sir you have got loan approval of 50000 Rs. No guarantor required. Interest rate only 7%. Should I send pay order to home or office address?”. First time when I received this call I was about to fall down from my chair. Quickly enough I told them “I am not interested in any Loan at moment”.  But conversation did not stop there. Some boy / girl in their early 20s advised me in polite tone that “Sir you keep the money it will be useful for you, you can invest in equities, also let me know if you are interested in Home Loan our bank has very attractive interest rates on Home Loan”. Somehow I used to politely refuse those people but also a thought used to touch my mind “Should I have taken it?”

So something had changed dramatically. From time when borrower used to convince lender on viability of his plan to a time when bank (representing lender here) is busy convincing new and new borrowers who have never applied for loan. The concept of taking capital adding hard work and becoming successful had gone. New concept was take capital (loan), buy shares / home / land / anything; it will raise in value automatically you will get success -- no hard work required. Many people called it “Golden Era” but I never believed so. Time that allow people to succeed without hard work cannot be golden era on other hand it undermine hard working people and set a wrong message that just by buying and selling something everyone can be prosperous.

Back then we were not smart enough to understand what is “easy monitory policy” and how central banks can inflate all these bubbles. Now when we have learned some of this, I am amazed to see efforts by governments to go back to “that kind of era” via simulation. One of the key parameter that made lending as borrower’s game was “Interest Rate”. In next articles we will see how interest rate can inflate bubbles and crash those.