Time to end personal guarantees for loans

It is time banks in India stopped being pawn shops and started doing actual banking, assessing the risk and viability of the projects they finance, instead of fully securing their loans with not just collateral from the business they lend to but also personal guarantees from the promoters. Demanding that entrepreneurs risk their personal assets to conduct business is to violate the basic notion of limited liability. The reason why personal guarantees seem so normal in India is the way businessmen have, in the past, padded project costs, got overly generous loans sanctioned, siphoned money out of their companies and endangered the viability of projects for which they took out the loan. There has to be a break from past bad behaviour on the part of promoters and on the part of banks.

What the demand for personal guarantee for loans to businesses underscores is the need for a functional market for corporate bonds, so that financing becomes arm’s-length. Clearly, banks have been emboldened by the Supreme Court ruling that allowed the invocation of personal guarantees against defaulters (read: even in cases where default on the loans so guaranteed led to insolvency resolution proceedings). A legal agreement with the bank to hand over personal assets in case the borrowing entity defaulted on loan repayment is binding on the promoter. This should hold for existing loans. On fresh loans, banks must not ask promoters to furnish a negative lien on assets owned by them. Instead, they must become more skilled at assessing the risks.

Financing long-gestation projects with bonds will not only avoid the asset-liability mismatch that comes with bank loans but also prevent dodgy lending practices, besides giving avenues to deploy long-term savings.