Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

CHAPTER – II
REVIEW OF LITERATURE

2.1 INTRODUCTION
An academic study on how a large bunch of Indian urban population emanating from
different strata manages their debts is very important and pertinent in the context of
policy framing by banking as well as government authorities. Before taking up such an
exercise, an attempt is made in this section to present a review of the available studies in
the relevant area. The review of literature is divided into two main categories viz. review
of literature on the subject related to debt and review of previous studies on the subject of
credit and debt.

2.2 TYPES OF BORROWING OPTIONS

There are a variety of options available in our country for borrowing money. These
options vary as to the tenure for which the amount is lend, the rate at which credit is
given, stipulations connected with borrowings, and the formal and informal nature of the
channel through which the amount is borrowed. The criteria of lending money by a
specific channel may also differ for different individuals depending upon their level of
income, prospects of income in future, debt repaying capacity, credit worthiness, market
standing and so on. Individuals enjoy both formal as well as informal channels of
lending. Among the formal channels, loans from banks and other financial institutions
and money lenders are included. Whereas, the informal means of borrowing options
include borrowings from friends, relatives, neighbours, local shops and occasional
lenders, etc. In general, the formal channels of borrowing options can be classified into
two kinds of loans viz. secured loans and unsecured loans. A secured loan is a loan where
a lender has access to some kind of asset. In case the borrower makes a default in
repayment of the borrowed money, the lender can liquidate the asset and take his full or
partial money back. As there is a sense of security in secured loans, they carry a lower
rate of interest. However, an unsecured loan is a loan where the lender has no access to
any asset of the borrower. In case there is a default in its repayment, the lender will have
no asset to get him reimbursed for the money loaned. That is why these loans carry a high

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

rate of interest. Personal loan and credit cards issued by banks are examples of unsecured
loans. Despite carrying a high rate of interest, people go for these alternative loans
because the processing of these loans is much faster and better. Some of the different
kinds of loans are briefly explained hereunder:
1) Loan Against Gold – This is one of the best options in India to borrow money
through secured loans. A borrower can pledge his/her gold jewellery and take a loan from
banks and companies like Muthoot Finance or Mannapuram Gold. Processing of gold
loans is extremely fast and ranges between few hours to 2 to 3 days depending upon the
case. A low rate of interest is charged if a high margin of safety is provided to banks or
companies. For example – if a borrower is ready to pledge gold worth Rs. 10 lakhs for a
loan of Rs. 5 lakhs, then the banks have an adequate amount of margin in case default is
made. Therefore, in this case, the rate of interest will be on the lower side. Whereas, if a
borrower is ready to pledge gold, which carries 80 to 90% of the amount of loan
demanded, then the rate of interest will be on the higher side. Generally, the interest rate
asked for gold loans ranges between 12 to 15%. There are no pre-processing charges.
Apart from the borrower’s address and identity proof, too many documents are not
involved.
2) Loan Against Insurance Policies – An individual who requires money and is ready
to be indebted can borrow money by pledging his LIC policy if it is eligible for obtaining
loans. Usually, a person can get maximum 90% of the surrender value as loan. The loan
can be borrowed from LIC or from banks. In case a borrower fails to repay the loan, then
the policy will be surrendered.
3) Loan Against Fixed Deposits – In case an individual has a fixed deposit with a bank
for a long period of time and do not want to break the fixed deposit in between because of
running urgent requirement of money, then he may borrow loan against this fixed
deposit. The rate of interest paid on such loans is usually 1-2% higher than the rate of
interest earned on the fixed deposit. The loan amount available to the borrower would be
around 75% to 80% of the current worth of the fixed deposit.
4) Loan Against Property – A loan can be raised against residential as well as
commercial property. Banks normally give loan up to 50% of the market value of the
property or 30 to 40 times of the monthly income of the borrower. The interest rate

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

ranges between 13 to 16%, depending on the amount of the loan and the margin that is
offered by the borrower to the bank. Loan against property is generally recommended for
those households/ individuals who want a large sum of money to cater their requirements
like expansion of business, wedding or some big-ticket expense. This option is not
recommended to those whose requirement of money is not much and is restricted to just 2
or 3 lakhs of rupees. Loan against property carries processing as well as prepayment
charges. However, some public sector banks like Bank of Baroda, State Bank of India are
known for not charging prepayment penalties and have lower processing charges. The
interest rates on these loans generally remain fixed.
5) Loan Against Shares and Mutual Funds – A loan may also be sanctioned against
some approved funds and shares. Because, the value of the shares and mutual funds are
highly volatile in nature, the lending organizations demand a high level of margin.
6) Loan Against Provident Fund – With certain restrictions, a loan can also be availed
against a PPF account. Loan can only be availed from third year to the sixth year of
opening a PPF account. The amount of the loan will be 25% of balance in the account 2
years back from the date of borrowing.
7) Credit Purchases From Kirana Shops – Indians’ low per-capita income means
more frequent shopping with smaller outlays per store visit. A significant number of
Indian consumers do not have enough money to stock up. So, they buy goods as and
when required. The local Kirana store serves this need efficiently. With lower incomes,
customers are extremely price sensitive and often need credit, usually provided by
neighbourhood stores. Relationships and customer experience are especially influential in
India where the local shopkeeper enjoys trust and familiarity with customers. These
credits are usually made for those customers who are either frequent customers of the
shop or the shopkeeper considers the customer to be genuine and has knowledge about
the place of his residence and has other relevant information.
8) Borrowing From Friends and Relatives – Friends and relatives can often be a good
resource when seeking money to fulfill certain requirements. The people that are known
and trusted the most are many times the most logical choice to help an individual in
financing his necessities. But before approaching relatives and friends for money, it is
important to ensure that they have the financial means to make a worthwhile contribution.

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

2.3 RETAIL BANKING AND RETAIL LENDING

Retail banking has wider connotation and is not the same as that of retail lending. Retail
Banking refers to the efforts of the bankers to reach up to the customers on both fronts of
the balance sheet, i.e. Liabilities side as well as Assets side. Under the liabilities side, are
deposits and under the assets side, are the credit/ loan schemes of banks. While novel
retail lending products are introduced by the banks to compete effectively in the market,
the products which are prevalent in the industry and marketed by the banks are housing
finance, consumer durable finance, vehicle (two-wheelers and four-wheelers) finance,
personal loans, advance against future lease rentals, mortgage loans, pension loans, etc.
The contribution brought in by the borrower is termed as margin. Margin
requirements differ from one type of finance to others and they differ from one bank to
the other. There is no standard capsule of margin in this segment.
The rate of interest has been deregulated by the apex monetary authority which
suggests that the rate of interest offered by one bank for a retail lending scheme may not
match with the one offered by the other banks. The rate of interest is decided by the
individual banks.

2.4 CLASSIFICATION OF BANKING ASSETS

1) Standard Assets – A standard asset is one with respect to which no default in
repayment of principal or payment of interest is perceived, and which does not disclose
any problems nor carry more than normal risk attached to the business.
2) Sub-standard Assets – Sub-standard asset is one (i) that has been classified as NPA
for a period not exceeding 18 months, (ii) where the terms of the agreement regarding
interest and/ or principal have been renegotiated or rescheduled after the commencement
of operations until the expiry of one year of satisfactory performance, under the
renegotiated/ rescheduled terms.
3) Doubtful Assets – A doubtful asset means term loan/ leased asset/ hire-purchase asset/
any other asset that remains a sub-standard asset for a period exceeding 18 months.
4) Loss Assets – A loss asset is one where loss has been identified by the banks, NBFCs,
or internal or external auditors, or the RBI inspection to the extent the amount has not
been written off. Alternatively, it may be an asset that is adversely affected by a potential

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

threat of non-recoverability due to either erosion in the value of the security/ non-
availability of security, or any fraudulent act/ omission on the part of the borrower.

2.5 PROCESS OF GETTING LOAN/S

2.5.1 Process of Getting Home Loan
The following are the step by step procedure of getting a home loan:
Step 1: Application form – The process of getting a home loan starts with a formal
application for the loan in the HFC/ NBFC/ bank of choice. The application form requires
certain basic information about the applicant. This includes personal, residential, income,
employment, education details and details about the property, estimated costs and current
means of financing the property. Though the requirements may vary from HFC to HFC,
but there are certain things which every HFC will ask. The application form must be
supported with valid documents to substantiate the facts. Generally the banks ask the
applicants to submit the income proof, age proof, identity proof, address proof,
employment details, proof of educational qualifications, details about the property, bank
statements. The purpose of the entire exercise is to ascertain the suitability of an applicant
for a home loan. The income documents and bank statements provide vital information to
the bank regarding applicant’s financial health. Banks charge processing fee for every
home loan application. This fee is non-refundable. The processing fee varies from bank
to bank and generally ranges from 0.25% to 0.50% of the loan amount. This fee is used
by the bank to start and maintain the home loan process, including completion of the
various formalities during the entire period.
Step 2: Personal Discussion – The bank first evaluates the papers submitted and
summons the applicant for the personal discussion regarding the home loan applied for.
Step 3: Bank’s Field Investigation – Banks usually send their representatives to the
existing residence of the applicants or their offices for the validation of the documents
submitted.
Step 4: Credit Appraisal by the Bank and Sanctioning of Loan – This is the make or
break stage of the process. The bank or HFC will establish a repayment capacity based on
the income, age, qualification, experience, employer, nature of business, etc. to access
applicant’s credential. The bank can also refuse a loan application if any discrepancy is

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

found at this stage. But if everything goes according to the conditions negotiated by both
the parties then, the bank or HFC will sanction a loan that may be unconditional or with
some conditions levied.
Step 5: Offer Letter – After the home loan is sanctioned, applicant’s get offer letter from
the bank or HFC with the details like loan amount, rate of interest, fixed or variable ROI,
tenure of loan, mode of payment, general terms and conditions of the loan, special
conditions (if any). If the terms and conditions are agreed, the applicant has to sign the
duplicate copy of the offer letter and submit it to the bank or HFC.
Step 6: Submission of Legal Documents and Legal Check – At this stage, the bank
asks for legal documents of the property involved in applying a home loan. All the legal
documents of the property involved have to be submitted. The bank does all the legal
checks on the property. The documents remain with the bank until the repayment of
home loan.
Step 7: Technical or Valuation Check – The experts from the bank visit the site that has
to be purchased and value it as per the existing rules and regulations. It is the most
important aspect that the bank considers before financing any property.
Step 8: Registration of Property Documents – After the legal and technical valuation
of the property the draft documents have to be cleared by the lawyer and stamping and
registration of the documents is done.
Step 9: Signing of Agreements and Submitting Post Dated Cheques – After the
signing of the agreement, a bunch of post dated cheques are to be submitted as agreed on
the agreement paper.
Step 10: Disbursement – After the bank or HFC ensures that financing the property
involves no risk, they pay the final amount that is agreed upon. The mode of payment
varies from full to partial payment. In the case of under construction property, the mode
of payment is part payment and in the case of ready possession properties, disbursement
is full and final.

2.5.2 Process of Getting Vehicle Loan

While financing a vehicle from a bank, the purchased vehicle itself becomes the security
against the loan amount. The following is an eligibility criterion for a vehicle loan:

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

1) Minimum age of the applicant has to be 21 years

2) In case of salaried individuals, the loan applicant has to be employed for a minimum
of two years and has to be working in the present company for at least one year.
3) The minimum yearly income of the loan applicant has to be Rs. 1, 00,000 or more.
However, the amount differs from bank to bank.
4) Maximum age of the loan applicant at the time of maturity of the loan has to be 60
years (in case of salaried individuals) and 65 years (in case of self-employed individuals).
The age limit also differs from bank to bank.
A vehicle loan can be applied by submitting an application on paper to the
concerned bank or else it can be applied online by filling an online application form. In
India, the vehicle loan procedure usually comprises of the following steps:
1) The borrower needs to directly apply for the vehicle or auto loan to the bank or
financial service provider of his choice with all the necessary paperwork. While applying
for a car loan, few documents are required viz. proof of income, identification proof
(PAN card, passport, driving licence, voters ID, etc.), office address proof, residential
address proof, signature proof and last six month’s bank statements.
2) Once an application is received by the bank, the bank’s executives will substantiate all
the paperwork, residential proofs and they will also carry out some other official
procedures.
3) A credit appraisal will be performed on the application.
4) If the bank finds the application to be appropriate for the loan and finds all the papers
submitted to be genuine, then the amount of loan will be decided. Amount of loan is also
dependent on the applicant’s income, age, spouse’s income (if any), academic
qualification and number of dependents. Amount of loan also depends upon the total
amount of assets of the applicant along with the current liabilities and steadiness of
employment. Applicant’s savings and credit history is also considered while making a
decision on his loan application.
5) After all these formalities, the loan is sanctioned and disbursed to the applicant.
Just like home loans, the rate of interest charged on the loan may be fixed or
floating, depending on the choice of the applicant. If fixed rate of interest is selected by
the applicant, then the interest rate will remain same during the entire period of the loan.

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

However, in case of floating rate of interest, the rate of interest keeps on fluctuating in
line with the particular stipulations of the loan agreement. The amount of EMI will be
dependent on interest rate, tenure of the loan and the amount of loan.

2.5.3 Procedure of Getting Education Loan

Student loan also known as education loans or higher education loans are financial aids
provided by the private financial institutions, banks and government organization to help
the needy and eligible students to attain higher education in institutes of repute.
Education loans may be taken for higher studies in the country or for overseas
professional studies. To pay off an education loan is the responsibility of students after
the completion of their education. Student loans can broadly be classified into two:
government loans and private loans. Usually government loans are preferred by the
students largely because of lesser rate of interest. Moreover, these loans require the
interest to be paid after completion of education and that too in easy to pay installments.
Most public sector/ nationalized banks like State Bank of India, Punjab National
Bank, etc. and private sector banks like ICICI, HDFC, etc. offer education loans. Banks
offer education loan for tuition and other fees, maintenance costs, books and equipments,
cost of passage (for studies abroad) and caution fund/ building fund/ refundable fund. For
applying a loan, student should be an Indian national. The maximum loan sanctioned to a
student depends on the need of the individual and repaying capacity of the parents/
guardians. The rate of interest differs from bank to bank. The period of loan is
determined on the merits of each case, but normally would not exceed 5 years. The
repayment can also be accelerated on completion of the course, considering the earning
capacity of the student.

2.5.4 Procedure of Getting Personal Loan

A personal loan is considered as an all purpose loan. In most cases, it is sanctioned and
disbursed without any kind of security like shares, home, vehicle, etc. Apart from
nationalized banks, many foreign banks and cooperative banks offer personal loans.
Besides banks, some other finance companies and financial institutions also offer
personal loans. The rate of interest for such loans is generally more as compared to other

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

forms of loans discussed above. The lending rates differ from bank to bank and usually
range from 12% to 30%. There is no consistency as to lending period among banks.
Some banks usually permit repayment up to a maximum of 60 months. On the other
hand, most banks limit the tenure to a maximum period of 36 months. The following is an
eligibility criterion for getting a personal loan:
1) Minimum take home or gross monthly income of Rs. 8,000. The amount differs from
bank to bank.
2) Minimum age of the applicant – 21 years
3) Maximum age of applicant – 60 years. Though some banks allow the applicant’s
maximum age to be 65 years at the time of maturity.
Any salaried individual, self-employed professionals like doctors, lawyers,
chartered accountants, etc., self-employed non-professionals can apply for a loan
provided he/she meets the eligibility criteria. However, the amount of loan depends on
the individuals current earnings. Personal loans attract a service charge of maximum 3%
of the loan amount. The rate of charge differs from bank to bank. While applying a
personal loan, some of the banks do not even ask the purpose for which the loan has been
applied and the borrower is not required to provide a guarantor for his loan. Some banks
may ask for a guarantor. While applying for personal loan, income of the spouse can be
added. The repayment is done by issuing post dated cheques in favour of the lending
bank for an amount of calculated EMI.

2.6 REVIEW OF PREVIOUS STUDIES ON THE SUBJECT OF CREDIT AND

DEBT
Cox and Jappelli (1993) found that desired debt exhibits a pronounced life-cycle pattern,
increasing until the age of the household head reaches the mid-30s, and then declining.
Also, the gap between desired and actual debt is highest for younger households,
indicating that they would benefit most from the easing of liquidity constraints. The
probability of being constrained falls with age and is negatively related to permanent
earnings and net worth.
Duca and Rosenthal (1993) explained that debt limits are affected by household
income, wealth, credit history and ethnic background.

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

Rajan (1994) provides a rationale for why bank credit policies may fluctuate, and
why therefore credit constraints may be time-varying. In Rajan’s model, investors are
relatively forgiving of poor earnings by banks when other banks are also having trouble,
but are far less forgiving if a bank has poor earnings when most other banks are doing
well. Banks therefore loosen standards in good times in order to keep earnings high, but
will tighten standards (and suffer a great fall in short-term earnings) in periods when
other banks are experiencing difficulties and when it is thus more difficult for investors to
determine the bank’s relative strength versus other banks. Rajan shows that this type of
behavior can lead to cycles in which banks in general have relatively loose credit policies
during good times, and tighten standards as a group during bad times.
McCarthy (1997) finds that a rise in debt is associated with a future rise in
consumer expenditures. Whereas the delinquency rates on consumer loans have little
direct effect on consumer spending, but may have an indirect effect through credit
availability. Thus, the relationship of debt service burdens to consumption may be
complex and a rise in debt burdens may cause a rise in delinquencies, which leads to a
tightening of credit availability.
Murray (1997) argues that the debt burden of households, as measured by the
ratio of debt service to income, is helpful in forecasting the future growth of consumer
spending. He also argued that debt burdens should not be thought of as a leading
indicator of recessions, noting that households having credit problems represent a
relatively small portion of households.”
Sharma and Zeller (1997) argued that “females are less likely to default because
they choose less risky projects.”
The household debt servicing burden – defined as household’s required debt
service payments relative to their disposable personal income – is a measure of the
resources households must devote each month to service their debt. Dean (1999) “The
debt service burden could have a role in propagating shocks, as households may be more
likely to cut back spending in response to a negative income shock when their debt
service burden is high. Furthermore, lenders may be more inclined to tighten terms on
household borrowing when household debt service burdens are high.”

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

Jappelli and Pagano (1999) found that the breadth of credit markets is associated
with information sharing. Total bank lending to the private sector scaled by GNP is larger
in countries where information sharing is more solidly established and intense. They also
found that defaults are mitigated by public and private information sharing.
High debt service burdens could make household consumption more sensitive to a
drop in income or in expectations of future income (Thomas and Michael, 1999). They
have further stated that “debt service burdens seem to be associated with higher
delinquencies on consumer loans.”
Lal (2001) identified that “the informal sector contributes to the housing finance
system through various sources. These include sale of personal assets such as personal
savings in cash and kind, sale of personal assets such as jewellery, land and agricultural
property and borrowings from friends, relatives and informal money lenders and credit
unions.”
The Housing Finance Manual for developing countries, while targeting the group
defines to whom the housing finance strategy is intended and made accessible defines,
“Housing finance is the capital made available to a household to improve or acquire a
house. Acquiring a house might mean building a house or buying one that has been built
by someone else. The house might be bought from any of a number of sources, including
the builder, another household or even a landlord and the seller may be an individual or
an Institution. The amount of housing finance required will depend primarily on the gap
between the cost of acquisition and the amount already available to the purchaser.
However, demand can only become effective, if the household is able and willing to
borrow the amount. Its ability to borrow will depend on the terms of the loan as well as
financial circumstances, its willingness is likely to depend upon its view regarding the
value of the house or improvement (Manual on Housing and Habitat Policy, 1998).
Prinsloo (2002) has defined debt (including household debt) as “an obligation or
liability arising from borrowing money or taking goods or services ‘on credit’, i.e. against
an obligation to pay later.”
Getter (2003) “consumer delinquency problems are mainly the result of
unexpected negative events that neither the lender nor the borrower could have
anticipated at the time the credit request was evaluated. The size of the household

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

payments burden has an insignificant effect on delinquency risk and very little effect on
default risk. Household financial assets that can be used as a buffer against negative
shocks also serve as a very important predictor of delinquency risk.
Debt delinquency refers to late debt payment behavior, which would immediately
result in lower credit scores, jeopardize opportunities to receive future consumer credit,
and adversely affect consumer financial well being (Getter, 2006; Lyons, 2003).
Avery et al. (2004) find that “longtime married individuals have lower rates of
default than recently married or divorced individuals.”
Debelle (2004) has identified that the greater indebtedness makes household more
sensitive to changes in interest rates, income and asset prices and this sensitivity gets
higher where most households have variable instead of fixed rate mortgages. Greater
household indebtedness and higher debt service levels lead to heightening of sensitivity
of households to a rise in unemployment. He has further argued that “lower interest rates
and an easing of liquidity constraints have led to a substantial rise in household debt over
the past two decades. The greater indebtedness has made the household sector more
sensitive to changes in interest rates, income and asset prices. This enhanced sensitivity is
higher where more households have variable instead of fixed rate mortgages.”
Charles and Mario (2006) using administrative data from an Italian lender of
unsecured debt found evidence that the extent of informal borrowing is positively
associated with borrower’s decision to default. This may be the case because access to
credit through family and friends can compensate for losing access to formal credit in the
case of default. However, there may be other considerations at work that would render
access to informal credit insignificant. For example, an indebted household may feel
ashamed asking relatives for additional credit or may not wish to reveal its financial
situation to close acquaintances.
Mc Kenzie, Liersch & Finkelstein (2006) has suggested that defaults may be
chosen for three reasons. The first is effort: choosing the default option requires no
physical action and can free one from laborious calculation. The second is implied
endorsement: decision-makers may infer a default has been pre-selected due to its merit
or the desire of those presenting the choice. Finally, defaults may result from reference

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

dependence: the default option may represent a reference point from which colors the
evaluation of other options as gains or losses.
“The increase in the household debt mainly reflects the efforts of households to
smooth consumption over time in response to shifting perceptions about future income,
wealth and interest rates, along with the effects of financial innovation that has reduced
constraints on the ability of households to realize desired consumption patterns.
Demographics have probably contributed to greater indebtedness. Decline in longer term
interest rates and increase in expected incomes may also have boosted debt to some
extent” (Karen and Donald, 2007). They concluded that “financial innovation has
facilitated household’s ability to allow current consumption to be influenced by expected
future asset values. When those expectations are revised, easier access to credit could
well induce consumption to react more quickly and strongly than previously.
Duygan and Charles (2009) noted that “adverse shocks are highly important. The
extent to which they affect repayment behaviour depends crucially on the penalty for
defaulting”. They also argued that “although repayment problems often arise from a
genuine inability to repay, some households seem to behave strategically”. They have
further added that “households in countries with an institutional environment which is
more efficient in the collection of overdue debts are less likely to fall into arrears”.
A study based on household debt in Australia (Davies 2009) has revealed that
“the increase in household debt is due largely to the sharp rise in housing debt. Several
factors have contributed to the strong growth in housing debt over recent years, the
principal one being the lower interest rates allows households to borrow more when they
take out their housing loans.”
“Even though housing is the largest asset owned by Indonesian households, most
home owners intend to leave their houses to their children rather than to reap the benefits
of rising house prices” (Santoso and Sukada, 2009).
Uppal (2009) in a study made to analyze the trends and growth in the retail
portfolio of various bank groups identified that in 2008, among the retail loans, housing
loans and auto loans occupy prominent places.
Meier and Sprenger (2010) in a field study, elicit individual time preference with
incentivized choice experiments, and matched resulting time preference measures to

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

individual credit reports and annual tax returns. The results indicated that present-biased
individuals are more likely to have credit card debt, controlling for disposable income,
other socio-demographics and credit constraints.
Rodrigo, Natalia & Roberto (2010) found that “income and income related
variables are the only significant and robust variables that explain default for both types
of debt. Demographic or personal variables are specific to one or the other type of debt
but not to both. For example, level of education is a factor that affects mortgage default,
whereas the determinants of consumer debt default include the age of the households
head, and the number of people within the household that contribute to the total family
income.”
Tufan and Lucia (2010) in their investigation on the relationship between credit
card debt and consumption using household level data found negative relationship
between debt and consumption growth. They showed that a one-thousand dollar increase
in credit card debt results in a decrease in quarterly consumption growth of almost two
percent.
Bandyopadhyay and Saha (2011) suggested that the borrower defaults on housing
loan payments is mainly driven by changes in the market value of the property vis-à-vis
the loan amount and EMI to income ratio. They also identified that default on home loans
also gets triggered depending upon the borrower characteristics like marital status,
employment situation, regional locations, city locations, age profile and house preference.
In a study made by Brever (2011) it was interpreted that “Household debt
portfolios reconciles well with time preferences of households”
Brougham et al. (2011) “Compulsive buying, defined as the inability to control
purchasing behavior, is higher among college-aged students than it is among the general
public. In a study of 628 students revealed that variables predictive of compulsive buying
varied depending on the amount of credit card debt that the student was personally
responsible for paying. The findings have implications for reducing compulsive buying in
college students.
“Compared with the average in America, married families with children were
more likely to hold mortgage, credit card and vehicle loans. In terms of debt burdens,
married families with children had the highest debt payment to income ratio, cohabiting

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couples with children and single females with children had the highest rate of heavy debt
to income ratio (over 40%) and of debt delinquency” (Jian and Rui, 2011).
Maria and John (2011) investigated that there is a differentiated levels of debt
servicing among women and men that suggests uneven debt burden sharing among
household members. By means of regression analyses, they demonstrated that low quality
jobs tend to lead to higher debt servicing. The results provide a nuanced and illuminating
picture of the interconnectedness of employment, financial stress and vulnerability.
Married couples with children and single females with children are more likely to
be late in debt payments. Household head’s age shows an inverse U-shape on the risk of
debt default (McCloud & Dwyer, 2011).
Moty Amar, et al. (2011) from their experiments revealed evidence of debt
account aversion. They identified that the participants consistently paid off small debts
first, even though the larger debts had higher interest rates. They also found that
restricting participant’s ability to completely pay off small debts, and focusing their
attention on the amount of interest each debt has accumulated, helped them reduce
overall debt more quickly.
Puri, Rocholl & Steffen (2011) identified that the loans of retail customers, who
have a relationship with their savings bank prior to applying for a loan, default
significantly less than customers with no prior relationship. Relationships matter in
different forms, scope and depth. Even the simplest forms of relationships, such as
transaction accounts are economically meaningful in reducing defaults, even after
controlling for other borrower characteristics as well as internal and external credit
scores. Relationships of all kinds have inherent private information and are valuable in
screening, in monitoring, and in reducing consumers’ incentives to default.
Financial deregulations started in early 1980s resulted in many financial
innovations that provided more credit alternatives for consumers to manage debts (Ryan,
Gunner and Peter, 2011).
David, Nyakundi and Wesonga (2012) while studying the loan repayment
behavior in savings and cooperative societies identified that the factors (loan purpose,
amount of credit obtained, loan processing and disbursement time, interest rate charged,
profit anticipated from produce sales, loan diversion, amount of loan diverted, number of

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

visits, borrower’s market place, income from relatives and friends, age and education
level) have an influence in loan repayment behavior. In their study reached to a
conclusion that “gender, size of the borrower’s family, loan purpose, amount of credit
obtained, loan processing and disbursement time, interest rate charged, profit anticipated
from produce sales, loan diversion, amount of loan diverted, number of visits by loan
officers, borrower’s market place, income from relatives and friends, age and education
level influence loan repayment behavior”
In a study conducted by Dimitrios, Angelos and Vasilios (2012) in Greece, it was
identified that, for all loan categories, Non-Performing Loans in the Greek banking
system can be explained mainly by macroeconomic variables like GDP, unemployment,
interest rates, public debt and by management quality. They found that the differences in
quantitative impact on macroeconomic factors among loan categories are evident, with
non-performing mortgages being the least responsive to changes in the macroeconomic
conditions.
Georgarakos and Furth (2012) in a study conducted in Europe stated that arrears
are more common among households living in regions with dense corruption beliefs, low
confidence in institutions and authorities, and a low fraction of religious people.
Moreover, high stocks of social capital, reduce the likelihood of arrears, net of the
influence of various potentially relevant factors. Households in these communities face a
higher hazard of losing standing in the group and access to the positive externalities of
social capital.
Stefano and Franceso (2012) studied the influence of attitude on consumer credit
decisions. He identified that the influence of attitude on consumer credit decisions cannot
be ruled out. Attitude toward credit appears to play an important role and is significantly
related to motivations for using credit and to the method of choice for financing
consumption.
According to the study made by Jack, Ralph and Richard (2013), “people
underestimate the amount of time it takes to eliminate a debt when payments barely cover
interest owed, and this effect was worse for those low in numerical skill. Less numerate
individuals tend to underestimate the monthly payment required to pay off a debt in three
years, whereas those more numerate tend to overestimate.”

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

As per US Survey of Consumer Finance, 2001, 27% of households report

simultaneously revolving significant credit card debt and holding a sizeable amount of
liquid assets. These consumers report paying on average, a 14% interest rate on their debt
while earning only 1% or 2% on their liquid deposit accounts. This phenomenon is
known as the ‘credit card debt puzzle’. “The transactions and precautionary demand for
liquidity appear to be a significant factor in accounting for the credit card puzzle”
(Telyukova, 2013).
Sarah and Lucia (2013) “Younger consumers are found to be borrowing more
heavily and repaying at lower rates than older generations. The accumulation of credit
card debt is found to continue over the lifecycle. This has implications for recent changes
in laws governing the credit card industry. Increases in minimum required payment rates
are examined and are found to increase actual payoff rates more than proportionately.
By applying multilevel regression to the Beginning Postsecondary Students
Survey Nicholas (2014) found four key findings. “First, attending proprietary institutions
is strongly associated with default, even after accounting for student’s socioeconomic and
academic backgrounds. Second, cumulative loan debt has a non-linear relationship to
defaulting. Third, minoritized and students from low-income families default at
disproportionately high rates; and fourth, unemployment and degree completion are
strongly associated with greater default rates. These findings counter the argument that
default is a preexisting condition.”

2.7 REVIEW OF PREVIOUS MODELS ON CREDIT AND DEBT

One of the objectives of the study is to create a model for the households through the use
of which individuals can identify their debt repaying capacity. However, development of
such a model is not a good idea unless and until a review is made of the existing models
on the subject.
2.7.1 Concept of Credit Scoring Model
Usually banks evaluate each loan on an individual loan-by-loan basis. However, for the
consumer loans, limited resources are devoted to analyzing the risk involved in its
financing. Therefore, lenders generally rely on scoring models and automation for
approving loans.

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

Although the first credit scoring implemented for banks and mail order occurred
already in the 50’s in the US. In housing finance the turning point was not until in the
90’s with the growth of automated statistical credit and mortgage scoring as a method for
underwriting and approving loans. Automated underwriting was previously used in credit
card and auto lending, but after 1995 mortgage business and consumer credit started to
benefit from it. The oldest and the most commonly used traditional scoring model was
the multiple discriminant credit scoring analysis for companies pioneered by Altman in
1968. Since then several other techniques have been employed widely. For example
Allen et al. (2004) summarize the four suitable methods to create a credit scoring model,
viz. the linear probability model, the logit model, the probit model and the multiple
discriminant model. All of these models identified financial variables that have statistical
explanatory power in differentiating defaulting firms from non-defaulting firms. The
objective of such models is to minimize the credit risk and default rates and to prevent
granting loan to bad customers and to avoid giving false rejection to good customers.
Scoring models use historical data combined with a statistical technique to
identify which customer characteristics such as age, income and marital status are the
ones that distinguish between customers who default and those who perform well. Credit
score is not a percentage nor is there an amount presenting the cut-off value for proper
scoring. Banks and financial institutions may develop their own credit scoring model or
may even purchase it from the developer. Creditors can construct the classification rules
based on the data of the previous accepted and rejected applicants. First, the old
customers are divided into two groups: those who defaulted the loans and those who did
not. Second, their socio-demographic and behavioral characteristics are evaluated with
the help of empirical modeling. Information such as income or age can be kept as
continuous variable but most often is transformed into categorical value. After deciding
suitable thresholds each variable or category is given scores. Every new customer is
evaluated based on these sub-scores and the summed score value is compared to the cut-
off value. The managers need to determine a suitable cut-off value to correspond their
business and risk management. The value indicates how much risk they can adopt and
what their presumption of the default rate is. If a customer is given more points than the
fixed cut-off value, he is admitted credit otherwise rejected.

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

Linear probability model, probit model and logit model estimate the default rate
based on the historical data on loan performances and the borrower’s characteristics. The
idea of linear probability is to look up for a linear combination of explanatory variables.
It assumes there is a linear relationship between the default rate and the factors. The
probit model assumes the probability of default is logistically distributed in the logit
model and discriminant analysis divides borrowers into high and low default-risk classes
(Mester, 1997).
Weizhuo (2010), explained that, discriminant analysis presents the critical
assessment of the use of discriminant analysis in business. However, Hand et al. (1996)
show that the discriminant function obtained by segmenting a multivariate normal
distribution into two classes optimal discriminant function. Problems also arise in testing
for significance of individual variables when the assumption of normality does not hold
and therefore we cannot perform statistical inferences (Rosenberg and Gleit, 1994).
According to Collins and Green (1982) the linear probability model could present
reasonable prediction results compared to discriminant analysis and logit models.
However, Pyndick and Rubinfeld (1998) and Greence (1997) indicated that the linear
probability model could not predict the default rate, but the predictive value might not
necessary lie between zero and one. Moreover, because the variance of the models is
generally heterscedasticity, it leads to inconsistent estimation problems and invalid
conventional measure of fit such as R2.
According to Hand and Hanley (1997) the logistic approach is a more appropriate
statistical tool than linear regression, when there are two discrete classes (good and bad
risks) defined in the model. This gives the logistic approach superior classification rate.
The probit model is very similar to the logit model. The logit model is generally preferred
to the probit model because of its simplicity (Barney et al. 1999; Novak and Ladue, 1999;
Lee and Jung, 1999). Clarke (2005) explained that logistic modeling approach is
commonly used to model the bank’s lending decision.

2.8 WEAKNESS OF PREVIOUS LITERATURE

Organized or formal research studies that have been conducted in India and abroad relate
mostly to the reasons of indebtedness, tools for measuring the debt burden of households,

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Personal Debt Management: A Study Related to Urban Household’s Debt Servicing Burden

loan repayment behavior, indebtedness and default rates on the basis of demographics
and so on. However, a formal research study on the management of debt and debt
servicing burden is something that is new and is a value addition to the previous studies.
Most of the studies have studied the demographics of the borrowers who fail to
meet their debt obligation as and when due. Some of the studies have also mentioned the
determinants that result in borrowing and default. However, the researcher has found that
there is a gap in research in terms of contribution of each individual factor in the decision
of a household to borrow. Similarly, the previous researchers have not covered the extent
of contribution of each individual factor that may result in intentional or unintentional
defaults by households.
As per the literature studied, there is no single method that can be regarded as best
for estimating credit scoring model and new methods continue to evolve. However, the
logit models and neural networks have been applied frequently in the previous
researches. Most of the studies have focused on finding the best possible technique to
build a credit scoring model for banks and other financial institutions. However, there is
no such model that can give an idea in a simple way to the borrowers about their debt
repaying capacity in the future. Therefore, there is a requirement to construct a model
which can serve as a guideline to the borrowers about their debt servicing burden so that
they themselves can identify whether they will be in a position to repay the debt or their
name will be enlisted with CIBIL as a defaulter.

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