Financial Daily from THE HINDU group of publications
Saturday, Feb 23, 2002
Money & Banking
NBFCs struggle to rid trade of subvention
CHENNAI, Feb. 22
NON-BANKING finance companies (NBFCs) are finding the practice of `subvention' an irritant, but are unable to get around it for a lack of industry-wide consensus on rejecting it.
`Subvention' refers to the practice of original equipment makers (OEMs) extending a discount to the financiers rather than to the consumers, and asking the financiers to pass on the discount to the consumer in the form of lower interest rates.
This suits the OEMs because they can lower the prices of their products (in a depressed market) without the market getting any wiser about it.
For example, if a car manufacturer wishes to reduce the price of a car from Rs 5 lakh to Rs 4.5 lakh, there are difficulties associated with that. First, there will be a loss of image. Second, when the market picks up and the manufacturer feels he can get Rs 5.5 lakh for the car, he will have to raise the price by Rs 1 lakh as against only Rs 50,000 if he had not reduced the price earlier.
The manufacturers get around this problem by giving the financier a discount the `subvention' and asking the financier to pass it on to the customer in the form of a lower interest rate.
The interest rate is usually fixed by the manufacturer, who tells the financier, `you will have to lend at this rate, if you want to take this subvention.' If the financier does not accept either the interest rate or the subvention, the manufacturer goes to the next financier willing to do so.
But for the financiers, this practice is fraught with problems. The rate fixed by the manufacturer is fine, and is arrived at based on IRR calculations.
Says the Managing Director, Investment Trust of India, and a former Chairman of the Equipment Leasing Association of India (ELAI), Mr P. S. Balasubramanian: "There are two key underlying assumptions in the IRR calculations first, that the borrower will pay his dues on the due date and second, that the company will be able to deploy the money again on the same date at the same rate." Should even one of these assumptions fail, the IRR calculations go awry. This happens more often than not.
Secondly, if the manufacturer withdraws the subvention, the financier has to raise interest rates, which is not good for his business, particularly if the market rates of interest happen to be falling.
According to Mr V. A. George, the incumbent Chairman of ELAI, the practice of subvention began in 1998 in the commercial vehicles industry.
Today, each NBFC would like to refuse subvention from manufacturers, but is unable to do so for fear of losing business to a competitor.
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