Mohd Sikander observes that the debt-based financing system goes against moral and social ethics as it fails to attain the objectives of social justice, to ensure economic development and to alleviate poverty. He also calls upon the banking industry to offer equity finance based on profit and loss sharing in a co-operative manner to the large segments of masses by doing well-established due diligence and credit monitoring techniques.

India, an agricultural country with the second largest population in the world, faces severe poverty problem. As per poverty statistical data 2022, more than 85 million people are forced to live in extreme poverty in India. And, every fifth Indian is poor, according to the definition of poverty derived by the World Bank. Poverty is the reason that affects billions of people around the world, and the nation where poverty has been particularly pervasive in recent years is India.

The factors that lead to poverty are unemployment, illiteracy, social injustice, lack of government support and high cost of domestic households. Cost of stuff is increasing day by day. Even essentials are being out of reach and too expensive for a large population. According to a study made by World Food Programme, poor households are spending 60%-80% of their income on food.

Another important reason of increasing poverty is an increase in unemployment ratio. A person is said to be unemployed or not having a job when he or she is looking for work or willing to work at the prevailing wage but is unable to find the job. Unemployment, lack of good jobs and lack of credit facilities create unrest in society. To overcome the problem of poverty and unemployment, the government has launched several schemes. All the schemes can be availed of from Public as well as Private Sector Banks, Regional, Rural and Co-operative Banks, Micro Finance Institutes (MFIs) and Non-Banking Finance Companies (NBFCs).

All the schemes offered by the government are debt-based. Debt-based financing is the core operation of banks and financial institutions based on unfair enrichment of property through interest compounding on loan. Banks give finance to customers based on their credibility, capacity of capital employed by the borrower, capacity of repayment of borrowed fund and the amount of collateral a borrower can provide. Satisfying all these criteria at the same time is not possible for all borrowers. It causes income gap for those who have access to financing and those who are being barred from doing this. It is witnessed that the prevailing system of financing is favourable at large for corporate clients and businesses based on strict evaluation and due diligence. 

The debt-based financing system can be sought from micro and macro perspectives. From the micro perspective, we can see that, in order to achieve social justice in the society especially for the poor it is not possible through the debt-based financing system. Under the present debt-based financing on account of transaction to occur between the borrower and the lender, there is need to have trust between the two, which mostly depends on availability of collateral, which many times the poor don’t have. Therefore, poor or small business plans are un-bankable as they cannot borrow funds. This can be seen in Indian financial market, where the lender takes advantage of the poor and charge them exorbitant rate of interest. That is, high credibility, collateral and repayment capacity charge low rate of interest, and low credibility, collateral and repayment capacity charge high rate of interest. This goes against moral and social ethics.

If we look at the objectives of social and economic justice, the aim is protection of individuals, family unit and societal wellbeing.  A man is required to maintain his dignity and is required to put food on the table of his family, with debt financing system a man is encouraged to live beyond his means. Consequently, Credit Cards and Personal Loans are easily available on monthly repayment in instalments even without collateral based on credit score for individuals in debt-based financial system. In order to achieve dignity, it is essential especially for the poor that they have access to the borrowing on an ethical and fair basis, so that they have opportunity to attain dignity in the society by becoming successful entrepreneur but not being indebted.

From the macro perspective, impact on overall performance of economy can be reviewed in many ways, that debt-based financing is really terrible as it is prompt speculation which leads to instability to the overall economy. Under the prevailing system, there is a separation of financial sector and real sector economy. Financial sector, which is debt-based financing system, is backed by financial assets. Flow of money runs within the financial sector. Instability harms the real sector economy also such as unemployment, poverty, inflation, etc. although there is no contribution from financial sector to the real sector. Hence, adverse effects of financial sector are felt by the real sector economy.

Another form of financing is Equity Finance. In equity financing, people come together and form a venture or partnership business. They contribute with a sum of capital; this results in the degree of owning share or shares depending on the contribution. In case of an individual, he may serve as the sole proprietorship and the financing would be in the form of owner’s equity capital. Equity-based financing constitutes investment activities which involve real economic activities by two or more parties entering into a contract and contributing to the capital or management of partnership with similar rights and liabilities by taking risk and at the same time with an attainable amount of profit and loss to be shared by them according to the proportional ratio or pre agreed terms.

In common parlance, a business is required to purchase fixed assets like land and building, plant and machinery, etc. These assets are regarded as the foundation of the business. The capital required for these requirements is termed as fixed capital. Part of the working capital is also of permanent nature.

To meet the requirements of the short and long term finance a business depends on many factors and have two main sources of finance like owners’ capital and borrowed capital. Owners’ capital includes equity finance, preference share finance and retained earnings of the business. The borrowed capital, on the other hand, includes the debentures and term loans from banks, NBFCs and other financial institutions. Equity finance can be done in a very moral manner and principle of co-operation through participation. The objective of social justice can be achieved when financial institutions open their doors for equity finance and flow the funds to the small sector business based on profit and loss sharing agreements.

So far as the attainment of objectives of social justice, economic development of the country and alleviation of poverty is concerned, the Government of India has introduced several schemes like Make in India, Startup India, Ease of Doing Business, etc. In line with these developments, banking and finance industry is also required to undergo a paradigm shift in financing. Now this is the time for banking industry to offer the equity finance based on profit and loss sharing in a co-operative manner to the large segments of masses by doing well-established due diligence and credit monitoring techniques. This will clearly help the small-scale business and poor people. Farmers in particular will have the access of fund without charge of interest from financial institutions that will increase productivity and output. And the problem of poverty can be eliminated, and the society will become more stable.

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