The debt spiral embedded in easy bank credit

This article appeared originally in Gulf News: link to original article

I am going to be very frank here — I don’t like the idea of paying for what you consume in instalments.
This has now turned from the simple transaction of purchasing a car and financing it through a bank — with up to 60 payments (over five years) — to being a mechanism to finance anything … almost anything. So, with banks, this has been expanded from personal and car financing, speaking of only consumers here, to student loans and loans to finance school fees.
Besides that, this is now also being used by different retailers, some with the aid of banks and their credit cards and some with cheques written by the customer. So is this healthy?
To address this, I am going to divide it into, first, the financing done by banks and, second, financing done by retailers. First of all, financing of school fees can only be made on a short-term basis. With interest, as low as that may be, it means that this could turn into some other form of credit card debt that could boast interest rates of anything between 6 per cent to 36 per cent a year.
For banks, the model will only work if the amounts given are being paid as soon as possible — i.e., a very high turnover. This is because paying school feels would include an X number of children per bank client multiplied by other clients who would wish to do such a financing. As a result, funds available for other types of financing such as corporate, commercial, and personal would be reduced.
From a business and making profits perspective, banks will need significant interest to make up for the loss of other major financing opportunities. If not, then a significantly high turnover.
As for retail financing, that could be discussed with less criticism if credit cards were kept out of the picture. In such a case, the payback of the total price of the commodity would be done at the customer’s convenience as long as the retailer can do with such payments.
As for those done with credit cards, the same bank financing logic applies. And if a consumer is purchasing beyond their means, having the purchase financed with interest or without it would only end up with future trouble. So, again, is this healthy consumption?
There is the effect on households and the effect on the economy. Starting with the latter, consumption would fuel growth regardless of whether or not such a growth is being fuelled by debt. However, in the long run, this will be an issue that affects many aspects of the economy, such as the ability to borrow and the ability to spend.
This is applicable to both governments and households. As for the effect on household, the effect could be anything from continuous refinancing of your debts to ending up in jail. Remember, whatever you finance today is you borrowing from tomorrow’s consumption.
The problem is that many are not even aware if they are consuming the right way or not, consuming within their financial limits or not. To know that, try recording your expenses for three to six months and match those with your income whatever that is.
Then, see if you can balance your budget every month. Basically, are you saving money or are you spending more than your monthly income? If the answer is the latter, then that is debt fuelled consumption — possibly that using your credit card or cards.
As long as you can settle those, no issue. And as long as you pay instalments with manageable interest, that’s not an issue either. If not, you have an issue.
The last thought that I want to leave you with: could using debt to finance investments or to acquire assets be considered healthy? (Hint: consider interest paid, inflation, potential for capital gain if any, return on investment, and payback period.)