Should We Outsource Salary Advances to Third-Party Finance Companies? Let's Weigh the Pros and Cons

Do you think it is a good idea to outsource the Salary Advance to a third-party finance company? As I see it, the pros and cons are as follows:

Pros:

- Reduced administrative work in HR and Finance
- No blocked funds
- No strain in relationships with employees

Cons:

- Employees will need to pay interest
- Employee data may need to be shared
- Moral responsibility (if not legal) on the company

I appreciate your views on the same.

Regards,
hifly

At the outset, I must appreciate you for doing a little bit of homework. The general tendency among the members of this forum is to shoot a query and expect spoon-feeding. It's good that you are not in that category. Nevertheless, where you have erred is in your direction of thinking. Your pros and cons are based on wrong premises. How? Let me explain to you.

Definition of "Outsourcing"

First, let us consider the definition of "outsourcing." While running an enterprise, we engage in thousands of activities. Some are mission-critical, and others are absolutely routine. The activities that are "routine," the activities that belong to the "non-core" category, are outsourced. Outsourcing is a sort of delegation between two organizations. The dictionary definition of "outsource" or "outsourcing" is "Obtain goods or services from an outside supplier; to contract work out." Here, you are not buying anything.

Employee Welfare: Salary Advance

Your second confusion is on employee welfare. Why do we give a "salary advance"? Giving a salary advance is a sort of employee welfare. While running domestic activities, employees run short of money. To fulfill these domestic requirements, a salary advance is given. Generally, a salary advance is given for the number of days worked in the month. Therefore, the company does not incur any liability as such.

Employee Welfare: Employee Loan

Your third confusion is on "employee loan." This is also employee welfare. Generally, it is given interest-free. In many companies, they have a policy on employee loans. In this policy, criteria are defined for loan eligibility. Generally, the loan amount is recovered in three to ten installments. Two guarantors are required to accept the liability for default. Again, in this case, the company does not have much liability. Yes, interest is lost on some amount, but when you calculate, you will find it negligible.

Outsourcing and Employee Loans

Fourthly, when you say "outsource," what you probably mean is that the employee takes a loan from some bank or financial institution directly. All that you wish to do is to route the monthly installment through your company. Your post implies that the relationship is between the employee and the bank, and therefore, the company is free from liability for non-payment or default in payment.

Impact on HR and Admin Activities

Fifthly, you say that when employees start taking loans from some bank, it will free up the company's funds and reduce admin activity for HR. But then, my dear friend, if a loan or salary advance is "employee welfare," then is this not the responsibility of HR? By using the phrase "outsourcing," do we want to "wash hands off"?

Technology and Loan Management

Sixthly, a large number of payroll software are available. Nowadays, tracking employee loans is not that difficult. It gets reflected in the monthly salary slip itself. Some 25 years ago, when manual operations were there, during that time, the employee was issued a book wherein his installments were recorded. The 21st century is the IT century; even then, why should you have any problem?

Financial Implications of Loan Disbursement

Seventhly, when you say that by disbursing loan funds get blocked, let me ask you a question: what percent of funds are blocked against revenue or against the HR budget? Please confirm the parameters of your calculation also.

Direct Bank Loans and ECS Facility

Eighthly, if an employee were to take a loan from some bank or financial institution, then all that he/she is required to do is to activate the ECS facility. The loan amount gets deducted automatically from his/her account. Why would that employee involve his/her company in between?

Organized Loan Disbursement Business

Lastly, my dear friend, please note that there is an organized business of loan disbursement. The monthly interest charged is between 1 and 2 percent. Do you mean to say that these people have any software? All the transactions happen in cash. Still, they manage very well. They know who is liable for payment, for what time, and how much is the amount. Should HR be supposed to be smarter than these people? If they can manage everything on their own, why would HR of the 21st century want to do so-called "outsourcing"?

My comments may sound uncharitable. However, what I have done is minutely scrutinize the proposal as per my understanding. Please do not take my comments personally.

Thanks,

Dinesh V Divekar

Thanks, Dinesh, for your detailed response. I will add my response after we get a few more responses. Let me just clarify a few things:

a) I am talking about 'Employee Loans' and 'Salary Advance' combined.

b) There are many companies that do payroll processing. What if we get a company to manage the loans?

c) Employees continue to get the benefit of 'welfare' as the loan disbursement will be seamless. It will continue to be part of the HR process, except that it is funded by a third party.

Regards,
hifly

Why should employee loans be such a significant subject to bother about, or does it even merit outsourcing? I could not understand. I conduct training on purchase and inventory management subjects. In this area, "outsourcing" is a major area of study. Based on the theory of outsourcing, let me ask a few critical questions:

a) What is the total count of employees?

b) Do you have a well-designed policy on employee loans or salary advances?

c) In the last five years, what percentage of employees applied for a loan? What is the ratio of applications approved versus turned down?

d) What is the percentage of the loaned amount against the total HR budget? What percentage of interest was lost due to employee loans?

e) How many persons work in the loan department? What is the percentage of man-hours spent handling loan activities against the total man-hours in the HR department?

f) What is the budget for employee welfare? What percentage of funds is consumed for loans out of the total budget for employee welfare?

g) To recover the cost of processing the applications, is it worthwhile to levy some processing charges? Please note that processing charges are different from interest on the loan.

h) If a third party is involved in the disbursement of loans, what will be the cost implications? What savings will you accrue? How will you avoid communication gaps if you start deducting monthly installments of the loans taken from the third party?

g) In your second post, you mention that "Employees continue to get the benefit of 'welfare' as the loan disbursement will be seamless. It will continue to be part of the HR process, except that it is funded by a third party." Now, the question is, if the "third party" starts giving loans, how will it still be "employee welfare"? Can you please explain how disbursement will be "seamless"?

Other non-financial considerations:

g) If the disbursement of employee loans is stopped, will it impact employee motivation or morale? If yes, is the cost of low motivation or morale measurable?

h) By stopping this facility, how will you differentiate yourself from your competitors? Will it impact the brand image in the job market?

Please consider the above questions for conducting a Cost-Benefit Analysis (CBA). Your decision will depend on how you conduct the CBA.

Regards,
Dinesh V Divekar