This is an interesting way that Bajaj Finance used to grow cons durable loans - later copied by banks which got rapped on the knuckles by RBI. Thread.
You can buy something for Rs. 20,000. But someone offers you an interest free EMI loan for, say 6 months! As in you pay Rs. 20,000 / 6 = 3333 per month and take this thing. No processing charges, no other charges, so you're like why?
Obviously paying over 6 months is better than paying all at once. Some interest will be earned by your money simply sitting there in your bank account. But what's in it for the shop? For the finance company?
Now three entities need to be satisfied - the shop, the manufacturer of the thing, and the finance company.
You might just walk away saying Rs.20,000 is too much, I'll come back the next time. No one makes any money.
But at Rs. 3,333 a month, you're like: I can afford that.
You might just walk away saying Rs.20,000 is too much, I'll come back the next time. No one makes any money.
But at Rs. 3,333 a month, you're like: I can afford that.
To entice you to buy, they work together.
1) The manufacturer says ok, if the customer takes this 3,333 per month deal, I'll provide a 5% discount on the product (but not to the customer)
2) The Customer pays 20K, but the financier gives the manufacturer just 19K (5% less)
1) The manufacturer says ok, if the customer takes this 3,333 per month deal, I'll provide a 5% discount on the product (but not to the customer)
2) The Customer pays 20K, but the financier gives the manufacturer just 19K (5% less)
3) The manufacturer pays a commission to the shop. Possibly 10-20% or so, which would be the same even if customer hadn't taken the loan - but at least this ensures a person becomes a customer.
4) The financier, you think, is getting screwed. He pays 19K to get back just 20K in six months? That's just 5% over 6 months or 10% annualized? Isn't that too less?
We will now introduce you to the magic of "cash flow".
We will now introduce you to the magic of "cash flow".
The financier doesn't get 20K back after 6 months. He gets Rs. 3333 from you every month for six months. In effect, you are paying back principal every month (and some interest)
What's the interest rate earned by the financier?
What's the interest rate earned by the financier?
Remember, the financier pays 19K now, gets 3,333 for the next 6 months. That's a whopping 19% interest. 
Sometimes they say, just pay 1 EMI in advance. That's ok, you think. But what the financier makes, on just 1 advance EMI, is a whopping 27% interest.
That's a sweet deal for the financier. Then credit cards started to offer this deal. Unfortunately, RBI told banks: yo, excuse me, if you're getting a 5% discount from manufacturer, you *must* allow customer to get that discount too.
So now, when you get a zero-EMI offer from a credit card, they tell you, in a convoluted way, that you pay an interest etc.
But they still don't offer the discount to you yet (which is a violation of RBI rules but no one's seemed to complain yet)
But they still don't offer the discount to you yet (which is a violation of RBI rules but no one's seemed to complain yet)
This, as a whole, is a good thing. The manufacturer doesn't want to discount the product unless you're absolutely willing to buy. The shop doesn't care (but the 27% interest rate is high enough for the financier to pay a little extra commission to the shop also)
And for you, if you keep the money in a liquid fund at just 6%, you'll make back like Rs. 350 in interest - which is about a 1.5% discount for you, effectively. The difference between a 5% and a 1.5% discount isn't all that much to bother really. So you do win.
Effectively, this is great for commerce. The financier takes the risk that you won't pay, but that's not as much a risk really - the dishonest people are small in number anyhow. With a 27% interest rate you can easily take a few losses.
We explain some of this in our podcast at: capitalmind.in/2019/12/how-to…
Of course, feel free to ask questions!
Of course, feel free to ask questions!
