The best thing that has happened to Indian banks in the last fifteen years is the business of student loans. Until the late 1990s, not many people pursued higher education beyond a bachelor’s degree. And for those who did, after adjusting for inflation, attending an institution of higher learning was still affordable. Funds could be corralled from parents, relatives and friends. Whatever one did, taking an education loan from a bank was almost unthinkable.
A lot has changed since. Today, the cost of higher education in India is rising and, in some cases, compares with that in western countries. Tuition fees at IIM-A for a two-year MBA programme will set you back nearly Rs 18 lakhs. This amount doesn’t include other costs such as books, living, food and incidentals. At XLRI, the fees for the Global Business Management programme, which includes studying in the US and China for three month stints each, will cost you Rs 26 lakhs. This estimate does not include the travel costs or living expenses in these countries.
Changing mindsets
With consumer tastes, preferences and standards of living in India rapidly changing, the word credit is no longer a taboo. This is especially true if borrowing is for an investment, such as for higher education.
The thinking is that a good education investment will pay dividends in the long run through upward career mobility, higher earnings and a better standard of living.
Indian banks have been skilled at exploiting this sense of optimism in young people. They market education loans by heavily advertising in the media and, in subliminal ways, through underwriting arts and athletic competitions on college campuses. But what is little known is how profitable and near risk-free the student loan business has been for them.
Fuelling the business
Banks make money on the spread of a loan. They pay depositors a certain rate of interest, turn around and loan out the deposits to borrowers at a higher rate. The difference in the two interest rates, the spread, is the oil that fuels the banking business.
The spread on an education loan at most Indian banks is a whopping 4.0 per cent. According to the World Bank, interest rate spreads for all types of loans were just 0.8 per cent for Japan, 1.8 per cent in New Zealand and 2.9 per cent in China. The type of loan is a critical factor because it determines how risky the loan is.
Basic finance teaches us that the higher the risk, the higher the return, or the yield to the bank.
Education loans are of extremely low risk in India because of all the safeguards that an Indian bank employs before the loan is issued.
First, loan amounts are a fraction of the total cost of attendance. Some banks cap domestic loan amounts to Rs 10 Lakhs – an amount insufficient to pay for even one year of higher education at elite private institutions.
Second, even the smallest education loan requires parents/guardians to co-sign with proof of income.
Third, if the loan amount exceeds Rs 4 lakhs, a third-party signatory is generally required in addition to parent signatures.
And fourth, if the loan amount exceeds Rs 7.5 lakhs, banks require tangible collateral; typically this is real estate, to secure the loan.
The bank, essentially, is covering for default in four tranches. If the borrowing student fails to pay, it can go after the parents. If they too fail to pay, it can go after a third party. If the third party also defaults, the bank can reclaim the amount through the collateral to recover what is due.
In effect, the loan amounts to near-zero risk. Why should a near-zero risk loan demand such a Shylock-ian spread of 4.0 per cent?
Shylock-ian spread
The answer lies in the way Indian banks work. Education loans subsidise underperforming loans in other sectors, such as agriculture and small business. Profits from education loans help pay for bloated bank bureaucracies and compensation structures. For most families, a job for a member in a public sector bank results in a life well settled. A tenured position for up to 40 years, subsidised housing, liberal rotation and training programmes and a family-friendly working environment all help to sweeten the pot.
The student who has borrowed funds from the bank, meanwhile, has to slog it out in the real world to help bank employees maintain their cushy standards of living.
And the number of students seeking education loans is only likely to grow.
Last year, over 100,000 Indian students took a loan to study in the US alone. Tens of thousands more travelled to other destinations such as the UK, Australia, Ireland, Canada and New Zealand. Banks earn additional revenue through means such as foreign exchange commissions and transaction fees when these students begin sending their EMI payments back.
The education loan business is booming, profitable and ripe for disruption. There is a great opportunity for entrepreneurially minded B-school graduates to shake the status quo, lower borrowing costs and improve customer service. Takers, anyone?
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