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Tuesday, March 22, 2011

Education Loans: What is a good collateral

Most discussions on how to improve quality of education start with the suggestion that the colleges be allowed to charge a much higher fee than what they are being allowed currently. And immediately, someone will point out that our citizens cannot afford the cost of quality education. Predictably the discussion moves on to bank loans. While in theory, educational loans till Rs 4 lakhs are without any collateral, and easily given, in practice, students keep complaining about banks' reluctance to provide the loan to students from financially weaker background. Apparently, the default in education loans is rather high, and banks feel comfortable giving loans to only students of highly reputed institutions, or those who has a guarantor or a collateral.

One way out of this problem is to have the degree itself as a collateral. When the student applies for bank loan, there can be a tripartite agreement between the student, the bank, and the educational institution. The educational institution agrees that any certificate/diploma/degree/marksheet, etc., that the institute will give to the student will have a line that the student has not yet completed the loan repayment, and only after the bank informs the institute that it has been fully paid that the institute will provide a degree (or diploma, etc.) which will be "clean," that is, will not have any mention of the unpaid loans.

Assuming that the students will be very keen to have a clean degree, they will try their best to clear the dues. At any stage in life, some employer may insist that they have a clean degree (and hopefully, a lot of employers will insist that at middle level or senior level, all degrees be clean).

And if all students can be given Aadhar number on priority basis, and their degrees and certificates can be put in a national depository (as is being planned by the government) so that any employer or stake holder can look at the status of the degree, then it will not be possible for students to fake a clean degree.

Of course, this does not solve the problem fully. Some students will fail the course and never get a degree. Some students will go abroad where employers may not care about the loan, and, of course, even Indian employers may not care about this line. Also, if one is self employed, then one can ignore having a clean degree. But all these cases put together are still a small part of the graduate community, and the scheme will, I hope, improve the loan recovery by banks. And that will encourage banks to increase the amount disbursed as educational loans, and also reduce the interest rates a bit.


L said...

In this era of LinkdIn and Facebook, it may prove easier to discourage defaulters than previously. Most professionals need to be on LinkdIn or similar networks for professional reasons. Banks could post defaulters on such networks.

Amit Srivastava said...

Dr Sanghi,

Education loans are not really that successful as they are being made out to be. My experience tells me that banks are more interested in giving out loans to students whose parents can actually afford to pay the fee. I could not get the loan (though I didn't try too hard) even after getting into IITK, while most of my batchmates who took loans were from pretty good financial background.

Saurabh Nanda said...

Sir, in a perverse way, shouldn't the institute be a co-guarantor (if not the sole guarantor) of the loan. It is mostly because of the institute's education, reputation, & placement process that the student will land up a job and will be in a position to repay the loan.

For cases where the institute is a co-guarantor the loan can be given out in tranches. There can be yearly benchmarks for the student to meet to be able to get the next tranch of loan payment.

The benchmarks can be quantitative and qualitative to help the institute ascertain whether the student will complete the degree with a certain CGPA & whether he will possess the behavioral attributes to get placed in an adequately paying job.

Dheeraj Sanghi said...

@Saurabh, A good idea. But who covers that default when it does happen. If Institute is the guarantor, then Institute pays for the default. Then either promoters pay for it (Government in case of IITs) - which means that Institute has no incentive to do due diligence. It can guarantee all loans. Or else, it comes from tuition - so higher cost for all students - something that students are not going to be happy about. The third option is for the banks to increase the interest rate, and share some of the profit with the institute, and this fund is used to pay for the default. But this increases the interest rate. Since banks can do the due diligence much better than the Institute, therefore, when they do it, they will make sure that the defaults are lower, and hence the interest rate is lower.