Explain any three disadvantages of borrowing funds from specialised financial institutions. (2024)

FAQs

What are three disadvantages of borrowing money? ›

Loans are not very flexible - you could be paying interest on funds you're not using. You could have trouble making monthly repayments if your customers don't pay you promptly, causing cashflow problems. In some cases, loans are secured against the assets of the business or your personal possessions, eg your home.

Since this forms a part of debt financing, borrowed funds can take the form of loans, credit cards, bank overdrafts, bonds, etc. An increase in the borrowed capital leads to a decrease in the lender's wealth, leading to a loss for the lender.

Borrowing to invest, also known as gearing or leverage, is a risky business. While you get bigger returns when markets go up, it leads to larger losses when markets fall. You still have to repay the investment loan and interest, even if your investment falls in value.

Borrowing from abroad can be a double-edged sword. While it can provide a country with access to much-needed funds and lower interest rates, it also comes with risks such as currency fluctuations, political risk, and loss of sovereignty.

The most crucial disadvantage of external debt is that it often leads to a vicious cycle of debt for countries. The debt cycle refers to the cycle of continuous borrowing, accumulating payment burden, and eventual default. When a government's expenditure exceeds how much it earns in a year, it faces a fiscal deficit.

Borrowing money from family can lead to massive issues as usually a set repayment plan is never put into place. If someone has poor credit and the banks wont lend to them. they need to get their act together, and not expect family to bail them out.

What are the disadvantages of using loans to financial institutions to prevent bank panics? ›

It is disadvantageous to use loans to financial institutions to prevent bank panics. A moral hazard problem may be created when loans are provided to financial institutions. Firms are likely to take on risk if they know they will access the Fed loans since the Fed will bail them out if a panic occurs.

The cost of borrowing can increase over time, especially if interest rates rise. 2. Debt obligations: Borrowing capital creates debt obligations for the business, which must be repaid according to the agreed terms. Failure to repay can result in penalties, legal action, and damage to the credit rating of the business.

Pros and cons of bank loans

Interest rates on bank loans are usually lower than that in other financing methods (e.g. inventory and invoice financing). Bank loan applications require collection and submission of lots of paperwork. The process could be taxing and time-consuming.