What is the logic behind asking for a margin contribution from a debtor before you give a loan?
I can hear/think of three potential reasons:
1.) Skin in the game/deterrent: “I am ready to risk my little amount of hard earned money to get this big amount of money from you. If I do not repay to you, it means I have not done well to get my hard earned money back either.”
2.) Seriousness of purpose: “I am serious enough regarding the usage of the debt and have appropriate plans for utilisation that is good enough to give me the confidence to risk my own money.”
3.) Indication of ability to repay the loan
What is the difference in terms of risk that a lender is exposed to in the following cases?
a.) the lender gives a INR 10 lakh loan and takes a margin contribution of INR 2 lakhs.
b.) the lender gives a INR 8 lakh loan and no margin contribution.
If you have these two options which case will you lend to? Say everything else is the same.