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Financing higher education: New directions in student lending

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From a student perspective, there are several challenges associated with paying for any form of higher education, which requires a greater level of commitment in terms of cost.

Financing higher education: New directions in student lending
Over 28 million students were enrolled in various Indian undergraduate courses during 2018-19. Despite having such a large undergraduate student population, India faces severe shortages of well-trained professionals in several fields such as medicine and business management. While there are several reasons for this, amongst the most important is the non-availability of student loans for a sufficient amount and duration.
Higher education in general, and medical education particularly, suffers from what is referred to as the problem of “the reverse tragedy of the commons”. While society can benefit through an increased supply of trained doctors, the costs and risks associated with obtaining this education are borne entirely by the individual. This limits both the supply of doctors and that of teaching institutions willing to train them.
From a student perspective, there are several challenges associated with paying for any form of higher education, which requires a greater level of commitment in terms of cost. Barring a few students whose parental or personal resources can help fund this education for them, for the rest, borrowing remains the only option.
Also, there are cost-uncertainties associated with the institution in which they are admitted as well as the total costs of the education, including if they decide to pursue a higher level of graduate qualification. Additionally, there are income and associated timing uncertainties that could generate very low earnings immediately after graduation.
All these can result in high levels of default for lenders, which limits their ability and willingness to lend in appropriate amounts; for appropriate durations; and at appropriate rates of interest. These affect students’ abilities to enrol for such higher education.
This is not a problem unique to India but is shared by several developed and developing countries. In the United States, for example, the average cohort default rates on education loans are around 10 percent.
The government and the Reserve Bank of India (RBI) have already taken significant steps to address these issues. Education loans of up to Rs 20 lakh qualify for priority sector classification.
Additionally, the government has established a Credit Guarantee Fund Scheme for Education Loans (CGFSEL) which is managed by the National Credit Guarantee Trustee Company (NCGTC) set up by the Ministry of Finance.
This provides a guarantee of up to 75 percent of the defaulted amount of uncollateralised education loans of up to Rs.7.5 lakh given by registered lenders at an interest rate not higher than 2 percent above the base rate.
With 29 registered lenders, all banks, the scheme has since inception covered a cumulative loan amount of Rs. 15,926 crore (as of March 2020), 78 percent of the loans guaranteed being in the category of up to Rs. 4 lakhs. In 2019-20, it achieved only 10.11 percent of the year’s target of 10 lakh loans set by NCGTC.
With some changes, CGFSEL holds the key to addressing the discussed challenges. Since the latest estimates of defaults are at about 10 percent for India according to the State Level Bankers’ Committee, it may be possible for CGFSEL to reduce its guarantee to as low as 10 percent and offer it on a second-loss basis, with the registered lender holding both the first-loss risk (of, say, 5 percent) and the residual senior risk of 85 percent, which will now enjoy a high rating.
With this approach, CGFSEL could potentially cover larger loan amounts beyond Rs 7.5 lakh (78 percent of the loans guaranteed were in the category of up to Rs 4 lakhs) as well as extend the maturity of the loan to as long as 20 years, allowing the students sufficient time to repay.
These partial credit guarantees and the performance of loan pools could also serve to build a rationale for a reduction in the currently very high provisioning requirements and risk weights imposed by the RBI on unsecured student loans. In collaboration with other institutions, CGFSEL could also facilitate the rating and sale of the senior portion of the underlying risk.
CGFSEL could be extended to loans originated by NBFCs too. However, the interest rate cap at 2 percent above the base rate effectively means that even expected losses have not been priced in and as noted by researchers at the World Bank in 2018, it is not necessarily conducive to the development of a vibrant education loan market.
In contrast, in the US, interest rates charged for education loans for medical schools can be as high as 13 percent. This represents a spread of over 9 percent above the relevant risk-free rate and has been key to ensuring that students get adequate access to well-designed loan products.
Another area that merits exploration is to get medical and other colleges offering technical and professional courses more directly involved in loan default management. CGFSEL can formally register them, just as it does lenders, and with the help of an independent rating agency, publish college ratings.
CGFSEL could also regularly publish cohort default rates on education loans by college and explore the possibility of declaring colleges whose cohort default rates exceed a certain benchmark as ineligible to participate in the guarantee scheme. This way, both students and lenders can be well informed about how the student cohorts of these colleges are performing after they graduate.
In the US, for example, if the cohort default rates exceed a given threshold, educational institutions are required to create a default prevention task force that will prepare and implement a plan to address the high default rates and prevent loss of access to Federal student loans.
For instance, Historically Black Colleges and Universities (HBCUs) in the US have taken a number of steps to ensure loan defaults for their students remain below the specified threshold. These include increased borrower awareness of obligations, borrower tracking, and increased contact with delinquent borrowers.
Governments the world over have sought to intervene in student loan markets using multiple mechanisms. One approach has been to increase public spending on higher education. However, even in developed countries, to keep pace with the rising demand for higher education as well as its higher costs (and private returns), other mechanisms, such as Government Guaranteed Bank Loans (GGBLs) and Income Contingent Loans (ICLs) have increasingly become popular.
While GGBLs are regular loans, ICLs are funded by the government and are a unique product in that the obligation to repay is contingent upon the income of the borrower crossing a certain threshold. Once this threshold is exceeded, repayments are charged to the borrower using the tax system making it cost-effective to administer.
It is also progressive since borrowers with lower incomes (either because they could not find a job or because they choose to work in disadvantaged areas) can potentially pay lower amounts or, if below the threshold, nothing.
For example, in Australia, the repayment rates as a proportion of total income under its Higher Education Loan Program (HELP) vary in the range of 1 percent to a maximum of 10 percent depending on the income levels.
India has already introduced GGBLs through the CGFSEL. It does not have ICLs yet, even if the IBA Model Education Scheme contains elements that are like that of the ICL, such as giving flexibility to banks to offer moratoria and telescoping of repayments over the loan tenure. But since its identification and income-tax systems are improving rapidly, this may well be a strong option for the government to explore now and to gradually move away from GGBLs.
There is a strong rationale for government intervention in student loan markets in general but particularly for higher and more expensive forms of education such as in the medical field. Such intervention can take the form of efforts to help private loan markets develop further and more direct interventions such as Income Contingent Loans.
—Nachiket Mor is a former banker and has served on the Board of Directors of the Reserve Bank of India and its Board for Financial Supervision for many years.  Sowmini G. Prasad is Research Associate at the Financial Systems Design Initiative, Dvara Research. The views expressed in the article are the authors' own.

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