Sunday, May 17, 2009

The Money Multiplier Effect

When a Central Bank (Fed reserve in case of USA and RBI in case of India) infuses money in the system/economy, the money multiplier effect is taken into consideration.

Let me try and explain the money multiplier effect.

When a central bank infuses say Rs. 100 in the economy, only a part of it goes to the banks. Some part goes back to RBI in the form of CRR and SLR. These rates are again decided by RBI. 

So when RBI is giving bank A Rs 100.00. The Bank  A is left with Rs. 80.00 post CRR and SLR. Out of this, the Bank A will lend say Rs 75/- to a Customer X. Now this Customer X will take the loan and deposit the loan cheque in some other bank, say Bank B. Bank B will again set aside the amount for CRR and SLR. And after that will lend Rs 60.00 to Customer Y. Customer Y in turn will deposit the loan cheque in Bank C, which again post CRR and SLR lends money to Customer Z. And the cycle continues. So Rs 100 get converted into Rs100 + Rs75 + Rs60 and so on. This is known as money multiplier effect.

So when FED or RBI say that they are infusing XXX million in the economy, the effect of that will be not XXX million but XXX million into the money multiplier effect. The central banks always take this into consideration while infusing the funds into the system. For if they infuse the amount in absolute requirements, the system will have excess liquidity. And that will lead to inflation.

Therefore my take is that as of now there is enough liquidity in the system. However, it will take some time for the same to show its effect. The fact is that its lack of confidence on the part of the general population that is delaying the economic recovery. The morale of a common man takes long time to build up, once broken. So every one is scared of spending now, and thinks that the future is bleak. Only when the future will look bright will the mass loose its purse's strings. Till then the slump will continue.

And might be, just might be the American consumers are becoming smarter and avoiding unwanted expenditure. If that is the case, then the recovery will take more time.

Friday, May 8, 2009

The US and Indian Rate Difference

The US and Indian economy differ on almost all economic parameters. And US comes on top in all, except fiscal deficit and BOP. Clearly, the advantage they have enjoyed due to technological break-through has propelled their economy for long.

All this implies that US citizens have seen development in all spheres of life at much faster rate than their counterparts in most parts of the globe.

So there is no harm in me saying that the loan market or "the credit market" is much more developed in US and it has a higher penetration per capital, when compared to India.

Now in such a developed market, the competition becomes real tough. Companies cut their margins to woo customers and keep their bottom line in blue!!

However, how safe is it to offer Low Interest Credit Cards in these troubled time? When banks are going bust, How can one trust an Individual?

Well, to start of with, these cards are not being issued to everyone on the New York street. The Bankers are smart chaps. They are issuing these cards to only those customers who are having a record of paying back. Either in full or in part. So what effectively is happening , is that the customers are moving from their existing cards, that are charging higher rates, to the Low Interest Cards.

These customers have all the intention to pay the amount. Like anyone, they just want to pay less interest. And therefore, they move. From a bankers perspective, its a RELATIVELY less risky proposition to issue a card to someone who is willing to pay at lower charges, than to issue it to someone at higher charges who has a higher probability of defaulting in the current scenario.

Also the main income for card issuers come from the transaction fees that they charge to the merchants and not from the interest income. So the fall in the interest rates should not make that big an impact in the P&L of the banks.

The Indian Market has a different scene altogether!! The Indians are not too much into banking, and therefore the cards penetration remain at a very low percent when looked at overall population. Therefore, the potential is still huge in our country. And this is the reason for higher interest charges in India.

Thursday, May 7, 2009

Back to Basics - Credit Cards - PART III

Why pay? Just use and forget!

Why should we bother paying back? With the number of banks and their eagerness to sell cards, I could get one new card every month, use it to the fullest and then just throw the card away!!

Well this would have been a great thing to do, except that we will be hurting our own credit history.

The banks, with the availability of computational power, are now maintaining database for all the customers, including their credit history. To avoid getting cheated/reducing losses, they even maintain a common database of the customers who have defaulted.

Every bank cross-checks this list for the defaulters before issuing credit to any individual.

So in case I default in a credit card now and apply for a home loan 5-10 years from now, my home loan application will be rejected due to my bad credit history. And this is applicable to all kinds of loan.

In fact, multi-national banks have gone a step ahead. They have inter-linked their operations worldwide.

I know a case in an MNC wherein a customer called from US to enquire about the outstanding on his card, which he had used 7-8 years ago. His outstanding was only Rs.80.00. When I enquired on how I could help him, he told that his home loan application in US got rejected due to the outstanding on his credit card in India. He was labeled as a defaulter for an amount of Rs. 80.00!! When I dug deeper into his account details, the outstanding amount was for Card theft insurance and not even a principal!!

Therefore the onus is on us to make sure that we use the card carefully. The banks will be getting more serious on the quality of the loans to be issued after the sub-prime debacle in US.


Some tips to use a credit card in a safe way.

1) Make full payment of the outstanding.

2) Use auto-funds transfer facility in the savings bank account to avoid last minute cheque lost/delay cases. Make sure that there are enough funds in the account on that day.

3) Try not to use credit cards while visiting third world countries like Thailand and other south-east nations. Card phishing is a very common activity there. Get prepaid international card instead.

4) Do not get over dependent on the card for meeting your expenses. Card payment collectors can be quite embarrassing.

5) Use cards only in known/reputed web sites. Try not using it for things like adult entertainment, online lottery, etc. There is a high possibility that card details will be phished.

6) If going at places like local Bar, ask them to swipe the card in front of you. Have seen numerous cases when the card is swiped multiple times for the same amount at these places. 

7) Try and keep a track of your purchases through card and cross check them with your monthly bill.

8) If unsure about the available limit, call customer care number and confirm before spending.

9) In case you are not using the card, call customer care and ask them to close the account. Don’t keep the account active under any circumstances. It leaves a loop hole for cheating.

10) Try and avoid taking loans which charge EMI directly to your cards. They are much more costly than similar loan products available otherwise.

11) Do not give your credit card to any one unknown. Not even to bank employees. I have come across cases during my small career in cards collection, where con men went to customers’ residence posing as a bank employee and asked the customer to hand over the silver card so that bank could issue them a gold level card. The customer, without cross checking the employee’s credentials and without cutting across the card, handed it over to the con men. The customer ended up with a bill of 50,000.00 at the end of the month. And he was forced to pay it too.

12) Cut the magnetic strip before disposing the card. Or even when sending it to the bank for cancellation.

13) Call the customer care as soon as you realise that you have lost your card.

14) Try to read the fine prints of the card application form if and when the time permits.

This list is not exhaustive though. We have to be careful, always. Today, plastic is as good as real money. A small noting of few numbers can cost u a good deal of money. Always be careful about your card. Its your liability.

Hope that the above details are useful to all. In case anyone has any doubts, please feel free to scribble back.

Friday, May 1, 2009

Credit Card - Pitfalls - PART II

·         Non Payment/Part Payment

Coming back to other ways the bank makes money out of credit card. When a customer is unable to pay the total outstanding due, it is advisable to pay at least the minimum amount due (MAD). Even when we pay the MAD, the card will be charged with interest @ 36% per annum rate (2.95% per month)!!


If we make part payment for a particular month (anywhere between MAD and Total Amount Due), we will be charged interest from the time we purchased the items and not from the billing date. So if I purchased the item on 9th of the month, I will be charged interest for the whole period of 60 days. That is from 09/08/08 to 08/10/08 (the third billing cycle).

If we are not able to pay even the MAD before or by the due date, we will be charged with Late Payment Fees. The fine depends on the type of card we are issued. A gold card will be charged higher fees when compared to a silver card. It can range anywhere between Rs. 250.00 to Rs. 1000.00!!

So if I am not able to make any payment from one billing cycle to another, I will be charged with both Interest and Late payment fees.

·         Cash Withdrawal

If we withdraw cash from our card, there are two charges that would be applicable to us. 1) Cash Withdrawal Charges. 2) Interest.

Cash withdrawal charges are usually a flat fee of 500.00 or 2.5% (depends on the card to card) of the amount withdrawn, whichever is higher.

The rate of interest charged is 36% pa. This amount is charged from the day we withdraw cash. So effectively, there is no interest free period for the cash withdrawn.

At the same time, when we are paying the amount after withdrawing the cash, we have to calculate the interest for the period and deposit that too. This has to be done because the amount that we pay to the card usually gets split the following way:

1)      Interest

2)      Other Charges

3)      Top-up features.

4)      Principal

So when we make cash withdrawal of 10k and make payment only of 10 k on the due date, there will be some principle amount that will be left as outstanding. The 10k will first be used for interest of that period, and then the cash withdrawal charges will be cleared. Finally the left over amount will be debited against the principal. We will be charged interest on that principal amount again in the next month’s bill.

·         Over the Limit Usage

Another charge is Over the Limit Charge. This happens when we unknowingly use the card for more than the prescribed limit. For example in a month I use the card heavily and forget the total amount I have utilized. So when I go for shopping again, I have only Rs. 5000.00 as my available limit. Instead I end up shopping for Rs. 10000.00. The credit card company will approve my transaction for Rs.10000.00 if I have a perfect payment history. They would not want a customer of theirs’ in an embarrassing situation.

Now, since I have over shot my credit limit, I will be charged will over the limit charges.

·         Unwanted Top ups

Credit cards have become a very sophisticated instrument from the time they were introduced. Many new products in the insurance arena have made keeping in mind this particular instrument. Insurance companies have tied up with various banks to offer their insurance product, both life and non-life, with the credit card. Some of the types of insurance offered on the card are:

1)      Mediclaim

2)      Card Theft Insurance

3)      Cover on credit card bill (in case the card holder passes away)

4)      Life Insurance (for Air travelling only), etc.

The premiums for these products are all charged on the credit card, usually on monthly basis.

If we have applied to any of these products, then it is ok. But usually we do not.  So how do they end up in our bills?

We are asked to fill a form while applying for the credit card. These products are there on the form. But due to negligence on our part, we over-look all of it. We just sign at the dotted line and give the form back to the agent, asking him to fill in the details. The agent in turn marks all these top-ups for us. And they end up in our monthly bills.

The best way to handle this is to fill in the form carefully. If you don’t want any product, put a cross in the check box. DO NOT LEAVE IT EMPTY.

In case they still end up in the bill, call the customer care immediately and ask them to cancel the product and reverse the charges. Do not postpone it because of the size of amount.

·         Free Balance transfer

Balance transfer is a tempting offer card issuers give to their competitors’ customer base. The offer says free balance transfer for 6 months. Well that is the case. However, not the whole balance is carried free for the six month period. A card holder needs to make a minimum payment, even in case of balance transfer. Therefore, basically it means that one can enjoy a period of 6 months as interest free if he keeps paying the minimum amount due. However, full payment has to be done for the purchases made in the new card after the balance transfer. They will not be a part of the interest free period.

Will come back with why should we pay back our bills and a few tips in the next one.

Thursday, April 30, 2009

Credit Card – A Double Edged Sword!! - PART I

Went to the movie "Confessions of a Shopaholic" and enjoyed every bit of it. However, there were some serious issues underneeth all the laughter and the jazz. The fact that Credit Cards can be a very serious problem, if not handled carefully.

To have someone’s money with you, for 50 days and pay it back with no interest is a very tempting offer. This is the biggest utility of a credit card. They offer you money, interest free for a 45-50 day period. All you need to do is pay it back.

So how does bank makes money? Well the primary source of income for bank is the transaction fees that it earns every time someone swipes the card. So if I go and purchase goods worth Rs. 1000.00 from Globus (called merchant), I will be charged only 1000 bucks in my card. Globus in turn will pay my credit card issuer 2% as transaction fees. This 2% is shared by my credit card issuer, Globus’s bank and Visa/Master card. The underlying assumption for this fee is that I will not purchase anything if I don’t have a card. The other source of income for bank is the customers who don’t pay the whole amount due by the due date.

Let us understand the basics of the card before we get to the usage part.


Item 1: Statement Date: This is the date on which statement is generated every month.

Item 2: Payment Due Date: This is the date by which one needs to clear the total amount due if he/she does not want to pay any charges/fees to the bank.

Item 3: Credit Limit: A Credit Card is issued to an individual based on his income and his spending pattern. The bank has all these details as you operate your salary account in it. It will approach you through one of its agent and ask you to fill an application form. Once you have filled in the form with all the details, the application is processed by the credit department of the bank.

The Credit department, based on pre-requisites, decides on the credit limit of the card. So in the above case, credit limit is Rs. 1.19 Lakh. This is the maximum amount till which the cardholder can spend from the particular credit card during one credit cycle.

Item 4: Available Credit Limit: This is the maximum amount that CC holder can spend till he clears his outstanding amount. Once he clears his outstanding, the available credit limit will be equal to his actual credit limit.

Item 5: Cash Limit: This is the amount up to which he can withdraw cash from an ATM. This is a part of the credit limit itself and not an extra limit. So if he exhausts his available credit limit, he will not have any cash limit either.

Item 6: Transactions: These are the details of his transaction. It tells him when, which shop and how much did he spent. At times, the name of the shop may appear different than where you swipe your card. This happens when the shop’s name and the name used for banking purpose is different. The transaction details show the banking name of the merchant. It will have all the transactions from 09/07/08 to 08/08/08.

Item 7: Opening Balance: This amount was his previous month’s outstanding.

Item 8: Payments/Credits: This is the amount that he has paid during the period 09/07/08 to 08/08/08.

Item 9: Total Due: This is the total outstanding that he needs to clear on 28/08/08.

Item 10: Current Due: Also known as MINIMUM AMOUNT DUE, it is usually 5% of the total outstanding or Rs. 200, whichever is higher.

Smart Usage:

The best way to use the credit card is by the following way:

Try to make maximum purchase on the date after the statement date of the card. In the above case, on the 9th of every month. So if he swipes the card for Rs. 1 lakh on 09/08/08, the amount will be reflected in his credit card statement for the month of September, i.e. on 08/09/08. He gets a 30 Day Credit free period.

Now, make payment of the total outstanding of the statement (Rs. 1 Lakh) on the payment due date, i.e. 28/09/08 in above example. That way he gets another 20 day credit free period.

This way one can use 1 lakh rupees for 50 days without making any interest payment.

Will continue with the other side of the cards in the next section.

Friday, January 30, 2009

The Growth Drivers

The following are the result of a class discussion. So i thank Ashok, Prasanna, Vijay, Francis and JK for chipping in. Also, our faculty for holding it.

We all know that the next growth driver for our economy, as touted by experts, is the finance sector. Well i had the same feeling. And was pretty much firm with them until i had this discussion. The Indian Financial Sector is expected to fuel the economy at 9%. Its the availability of smart man power and a government that supports the cause, that would have helped the sector boom.

All the steps taken before the Global Financial Meltdown, pointed in the same direction. The government was taking all steps to make Mumbai the next hub for the globe.

With the meltdown in place, the priority of the government changed. However, even the articles that were claiming the sectors as growth drivers stopped getting published. It was as if the whole world had gone wrong!!

Anyways, the faculty took a different standing. He said that financial sector cannot be the next growth driver. Rather it should never be!! 

His funda was clear. That for an economy to grow continuously, the growth should come from primary and secondary sectors. The growth should be in real terms. Tangible, hard products should be added to the economy.

The financial sector just grows on the books and in the banking systems (95% of money is E-money across the globe), in reality hardly any tangible stuff is added to the economy. And the example of US of A fitted in just right. The US economy that has been growing on the back of the financial muscle, has been adding the deficit of the budget and the unfavorable balance of trade, unchecked. The fact that dollar is the preferred currency for foreign trade across the globe makes it possible for the US to do so, too.

But then India is not so lucky. The INR is still used domestically and this will not allow the government to print as many bills as it wants. And therefore, the Indian growth will have to come from primary & secondary sectors.

Would like to know your take on this.

Friday, November 7, 2008

Consumerism... The Crippling Factor...

Ronald Regan is considered one of the most successful US president for the Economic measures he took. When Regan took over White House, he was left with an Economy which was on the verge of an Economic Downturn. To revive the same, he kicked in the habit of consumer credit. Thus started the fantastic rise of America as a Consumer Nation. The Americans consumed whatever the World produced. Regan was hailed as a great President and an Economist and thus the term "Regonomics" was coined.

What the world never imagined were the pitfalls of this. No individual can afford to spend more than what it earns. Imagine a whole nation doing it!! The saving of the Americans went from 25% during the starting of Regan period to -2% by the end of 2007!! The Americans, however, managed it seamlessly because Dollar was and still is the Currency for International Trade. It gives America the power to print as many green notes as it wants.

The current crisis, where-in due to a downturn in a particular sector of the world's greatest economy (housing in this case) can cripple the whole system and send shock waves across the globe, has torn apart the mythical success of "Regonomics". My belief is that had Mr. Regan looked at a longer and a more difficult way of solving the problem, America would have never faced this, and the World would have not seen a crisis like this.

What We Indians Need to learn...

Of late, predictable more so after the IT boom of 2000, the Indians too have started liking the taste of consumerism. The corporates, the banks, the retailers, the families even the finance minister, everybody wants more. More of everything. The corporates want more profit. The Banks want to give more loans. The Retailers want more footfall conversion. The Families want more luxury and the Finance minister desperately wants more economic growth. So what are the young Indians doing?? Consuming. And consuming more.

It is quite unfortunate that we have come to this stage. From a nation that was under a foreign dominance 60 years ago to a nation that wants to compete with the world economy giants today. I dont mean that we should not compete with them for the economic growth. But why choose the path that they have travelled and fallen into the pit? We Indians are smarter breed, and I am really proud of that. We have shown the world earlier that there is a different way to do things, by choosing Ahimsa over violence and getting freedom. And we can do again.

I wish I knew the answer, as to how to keep the economy running, without consumerism. But anyways, I believe that its about time that we Indians gave a thought on the reckless spending habit that we have developed of late.

I wish that people who read this piece do put in their thoughts on this, as the above are purely my views.