Loans for higher education

The Government of Andhra Pradesh is considering extending its flagship Pavala Vaddi loan scheme to helping students pursuing higher education. Under the Pavala Vaddi scheme, the state government have been providing subsidized interest loans (3%) to Self Help Groups (SHGs) who maintain discipline in their repayment obligations. More than the SHGs, higher education for poor students is an excellent example of a poverty eradication, as opposed to poverty alleviation, policy intervention. Higher education is one of the surest, economically efficient and least distortionary ways of ensuring that a poor family is lifted into a higher growth trajectory.

But instead of using Government intervention to catalyse and broaden a market in such lending, such schemes often end up trying to ambitiously cover all the beneficiaries directly by the Government. This is unsustainable and is a recipe for incentive distortions creeping in and the inevitable failure of the program. Any Government assistance should be leveraged to cover as many students as possible, while at the same time developing the market itself. Like for the farmers, the major problem for students looking for financing is not high interest rates, but the lack of access to credit. So more than focussing on the interest rate component, Government efforts should be towards creating this market.

For example, with the handsome interest subsidy, the student loan becomes similar to any high risk loan given by the bank. Therefore the arrangement reduces the banks to passive spectators in the whole lending process. The more enterprising banks should be jumping at this opportunity, which is a huge windfall, with little effort. The Government can get better results by incentivizing banks and fostering competition among them.

One way of doing this is to use the interest subsidy to provide a credit enhancement facility, that competing banks could draw on. In fact, there could be an auction or an open tender for finalising a select panel of banks eligible for accessing this credit enhancement facility. This would incentivize banks, open up competition, draw in private banks, broaden the market, and lower financing rates. It would also be a more efficient way of allocating scarce subsidy resources. Apart from this, for the initial period, the Government could continue direct subsidy for a few categories. While this is only one model, there are a number of other models available, all of which seek to leverage the interest subsidy to create a market.