Credit has the ability to build a modern economy, but the lack of credit has the power to swiftly and abruptly destroy it." - "Too Big to Fail"
Yesterday, while watching a movie, I had a craving for chips and coke. However, I realized I was out of cash. At that very moment, my Nepali instinct kicked in, and I rushed to the neighborhood grocery store owned by Ram Kaka to buy those items. My chosen payment method was "Lekhidinu la." Initially, this seemed like a typical Asian practice. Still, upon further reflection, I soon discovered that this method is widely employed by Nepali families, including transactions with milkmen, hardware stores, hotels, and even for purchasing medicines.
As I observed this system of debt, I noticed that individual grocery stores like Ram Kaka bore the debt. This sparked a curious idea to calculate the total amount of debt my family owed. To my surprise, we owed 2000 to Ram Kaka's grocery store, 3000 to the hardware store, and 1500 to the Gwala (milkman).
I would term this system of debt "decentralized debt" because the debt is fragmented into bits and distributed extensively. The overall debt of a person or family spreads across various avenues and local businesses, with small grocery stores and other small businesses bearing the herculean task of managing it. This type of debt often does not accrue interest, as is typical with bank loans or credit card debt, nor can it be easily transferred from one entity to another. Due to the absence of negative reinforcement mechanisms like fines and punishments, the debt holder lacks immediate urgency to settle the debt.
Now, let's imagine if I were in the United States. What would I have done differently? My best guess is that instead of asking the grocery store owner to maintain my account, I would have paid with my credit card. Additionally, the same procedure would be followed at hardware stores, electronics stores, and various other places. Wait for a moment... Who bears the loan in this case? Well instead of grocery stores the debt is borne by banks. The banks often accrues interest on this debt and this debt can be transferred to other entity.
How can it be transferred?
Here, allow me to introduce you to the concept of Collateralized Debt Obligations (CDOs). As per my understanding, this fancy finance terminology of CDO means that the debt borne by credit card companies in the form of credit card loans, home loans, auto loans, and student loans can be bundled together and sold as bonds.
A bond? What? Isn't a bond supposed to be an instrument where an investor invests money to get a fixed return on their investment? Yes, indeed. The debt, which was decentralized, would be bundled together in the case of the US, and such debt can be sold as bonds. I refer to this system of debt as "centralized debt."
The ultimate advantage of centralized debt lies in the availability of liquidity in the market. Suppose Ram Kaka's grocery store extends credit to 10 customers, and since these customers pay at a later date without additional interest, small businesses in Nepal have to operate with less liquidity. Due to the unavailability of a robust credit system, medium and cottage businesses in Nepal face liquidity crunches. Decentralized debt does not contribute positively to the overall financial system and often hinders the growth of local businesses by limiting liquidity. Having sufficient liquidity is essential for businesses to meet their short-term and long-term financial needs, manage their working capital effectively, and avoid the need for frequent loans, which ultimately leads to increased costs and higher prices for goods and services.
But what if a credit taker defaults on the payment? In such a decentralized system, there is no mechanism to collect the credit amount, and bad debts often have a severe impact on small businesses.
In the US, the availability of credit scores prevents individuals with a bad credit history from obtaining credit facilities. However, in a decentralized system, due to the absence of a credit tracking mechanism, a person with a bad credit history can simply relocate to a different location and start fresh without worrying about their past. Nevertheless, there is good news: we have initiated enrollment for the National Identity Card (NID), which functions as a social security number and can track an individual's credit history.
Despite the numerous challenges, why do Nepali people rely on decentralized debts? Well, the first aspect is the cumbersome credit system in Nepal, where people have to navigate a complex process to secure consumer loans such as credit card loans. Secondly, many people work in unorganized sectors like construction, farming, and agriculture, making it challenging to demonstrate stable income, which leads banks to be reluctant to provide credit.
The good news is that due to the growth of microfinance and cooperatives, it has become easier for people to access microloans for their consumption needs, with institutions better equipped to manage such debts.
Article By Nischal Bhattarai
Mechi Multiple Campus BBA 7th Semester