Biblical teaching on borrowings

Borrowings refer to the process of acquiring funds from external

sources. The Bible generally discourages borrowing Deut 28v12 You shall
not borrow. However, in case one as borrowed there are roles to be
played by both the lender and borrower.

1. Role of lender.
a. Transparency & honesty- Prov11v1 The Lord detests dishonest scales.
Lenders should not deal dishonestly with borrowers.
b. Ethical conduct- Micah6v8 What does the Lord require of you? To act
justly. Lenders are advised to act ethically and not hide additional
charges or commitments in loan contracts.
c. Treatment of interest- initially charging interest on borrowings was
considered as something to be avoided. Deut23v19 You shall not charge
interest on loans to your brother… you may charge interest to a foreign
resident. Therefore, interest charged should not be excessive.
d. Treatment of defaulters- it was common practice to treat defaulters
unfairly. Nehemiah5v1-19 We have borrowed money… and some of our
daughters have already been enslaved for other men have our fields.
This confirms that lenders would take over the defaulters assets
including children and tis brought distress and shame to the defaulters
hence lenders are encouraged to forgive outstanding debts. Deut 15v1
At the end of every 7 years, you must cancel debts.

2. Role of borrower
a. Responsibility & stewardship- the biblical aspect of stewardship
emphasizes responsible management and accountability for resources.
Luke 16v10-11 Whoever is dishonest with very little will also be
dishonest wit much. So if you ave not been trustworthy in handling
worldly wealth, who will trust you wit true rices? Hence borrowers are
expected to efficiently utilize the resources lent in order to make
repayments.
b. Debt management- biblical teachings caution against excessive debt
and encourage responsibility in repayments. Rom 13v7,8 Pay to all what
is owed to them… let no debt remain outstanding. Borrowers should
also consider the borrowing cost. Luke 14v28 For which of you desiring
to build a tower does not first sit down and count the cost… whether he
has enough to complete it?
c. Risk management- the Bible advises prudent decision making and risk
management. Prov 22v3 The prudent see danger and take refuge but
the simple keep going and pay the penalty. Prov 22v26-29 If you have
nothing wit which to pay, why should you have your bed taken away
from you? Borrowers are advised to plan their finances and determine
whether they can borrow and if not according to Ecc5v5 It’s better not
to vow, than to vow and not pay.

Objectives of borrowing costs

1. Cost management- for borrowers the objective might be to manage
borrowing costs effectively ensuring that they can access funds at lowest
possible interest rates.
2. Profit maximisation- lenders aim to maximize profit by charging
interest on loans that generates reasonable profit margin.
3. Risk management- both borrowers and lenders have objectives
related to risk management. Lenders assess the credit worthiness of
business to determine risk of defaulting while borrowers want to
minimize risk by negotiating favorable borrowing terms.
4. Financial stability- low borrowing costs may lead to excessive risk
taking and increase in prices of loans while high borrowing costs lead to
reduction of economic activity and financial distress of borrowers.
5. Market efficiency- borrowing costs ensures that capital allocated to
most productive use and help guide investment decisions and resource
allocation.
6. Strategic objectives- borrowing costs help organizations to align their
goals.
7. Capital structure- borrowing costs determine the management
decision to balance between choosing debt or equity financing.
8. Tax efficiency- borrowing costs- help managers choose the cost that is
tax deductible in order to reduce tax burden I.e interest expense from
borrowings are tax deductible but dividends paid are not tax deductible.
9. Operational efficiency- borrowing cost analysis aids to manage future
cash flows, liquidity maintenance and balancing of risk and return.
10. Credit ratings- borrowing cost help to manage credit rating of the
borrower so that there is possibility of receiving more funding in the
future.
11. Business growth- borrowing costs help management ensure the firm
can pay off those costs without risking future cash flows or misuse
resource hence enhance business growth.
12. Competitive position- borrowing costs indicate the decision to
choose gearing levels of the borrower I.e decide between debt or equity
financing. High gearing levels reduce cash flows and profitability and
lower gearing levels ensure borrower can maintain profitability and
competitive position in the market.

Classification of borrowing costs

According to IAS23 borrowing costs refer to the interest and other costs
incurred by enterprises in connection with the borrowing of funds. They
are also known as finance costs. Examples include interest expense,
commitment charges, bank fees, service fees, processing fees, legal fees
and others. They are generally categorized into fixed costs, variable costs
and semi variable costs.

1. Fixed costs- are expenses that do not change over the period of the
loan agreement. They are consistent and predictable and include:
a. Fixed interest on loans- interest rate is fixed regardless of changes in
market interest rate.
b. Interest rate on bonds- companies pay fixed coupon payments that
don’t change over the life of the bond.
c. Lease payments under finance lease- lessee pays fixed payments of
the leased assets costs.
d. Financing fees- these include underwriting fees and legal fees and are
normally capitalized and then amortized over the life of the loan at a
fixed costs.
e. Preference share dividends- a company that has issued preference
shares pay fixed dividends to the shareholders.

2. Variable costs- their amounts change during the life of the loan
agreement and are less predictable and riskier than fixed costs. They
include:
a. Variable interest on loans- interest payable to lenders change to
reflect current market interest rate.
b. Adjustable rate mortgage- for real estate loans where interest rate
changes based on reference market interest rate.
c. Performance based interest- link interest rate to borrowers financial
performance e.g debt to equity ratio, profitability ratio where of
company performs well interest expense decreases.
d. Floating rate bonds- interest expenses of these bonds adjust
periodically based on a bench marked rate over a period of life of the
bond.
e. Factoring costs- factoring is a form of finance where the business sells
its receivables at a discount and the discount allowed which is an
expense varies depending on the debtors ability to pay.

3. Semi variable- these consist of fixed and variable costs where the
costs remain fixed up to a certain borrowing level and change to another
after that level has been surpassed. Examples include:
a. Hybrid interests loans- interest rates are fixed up to a certain level of
borrowing which then moves to an interest rate that reflects market
rates.
b. Overdraft- businesses can take up overdraft on their bank balances
and some banks charge a fixed fee for a certain limit where additional
variable charges apply after the limit.
c. Introductory rate credit products- financial institutions may offer fixed
rates for the first year of the loan agreement as a promotion and switch
to variable rates after.
d. Performance linked interest rates- some lenders may offer fixed rates
within a range of maximum and minimum rates and based on
performance of the market change to a new range of interest.