For many entrepreneurs or small business owners in India, the terms associated with business financing can seem challenging. High interest rates can affect monthly payments significantly, making financial planning difficult. This article aims to demystify what drives interest rates on business loans so that you can identify the means of better terms to support the growth of your business effectively.
How the Economy Affects Your Loan Rates?
The broader economic environment plays a vital role in controlling the interest rates on Business Loans. Economic indicators such as GDP growth, inflation, and policy rates set by the Reserve Bank of India (RBI) directly influence what interest rates are offered to businesses. These elements are interconnected, impacting how banks and financial institutions calculate the risk and potential return on the loans they provide.
- GDP Growth: When the GDP grows, the economy is generally healthy, encouraging businesses to expand and invest in new projects. This increased demand for credit can lead to higher interest rates as banks look to capitalise on the heightened loan demand. Alternatively, banks might lower interest rates during a downturn to stimulate borrowing and economic activity.
- Inflation: Inflation affects the purchasing power of money, which is a crucial concern for lenders. If inflation rates are high, the value of the money returned on a loan decreases in real terms. To manage this, lenders may increase interest rates to make sure the returns on their loans maintain their value. So, if inflation rises significantly, a lender might increase the interest rate on a new Business Loan to offset the inflationary pressures.
- Policy Rates by RBI: The RBI’s monetary policy directly affects lending rates. When the RBI increases the repo rate (the amount at which commercial banks borrow money from the RBI), banks’ borrowing costs go up. In turn, they pass on this cost to consumers by increasing loan interest rates. On the other hand, if the RBI cuts the repo rate, banks will find it cheaper to borrow money, often leading to reduced interest rates for loan borrowers.
- Market Liquidity: The availability of money within the economy, or liquidity, also impacts loan interest rates. High liquidity generally means lower interest rates, as banks have more funds to lend. Low liquidity tightens the credit availability, pushing up the rates as the cost of funds increases.
Assessing Your Financial Health
Lenders thoroughly assess the risk associated with lending through factors like credit history and CIBIL score. A high CIBIL score, a sign of your history of creditworthiness, can significantly lower perceived risk, leading to interest rates that are more favourable.
A business with a CIBIL score above 750 might secure a loan at a lower interest rate than higher rates for lower credit scores. Further, a history of consistent, timely repayments can lead lenders to offer rate reductions on subsequent loans as a token of trust and reliability.
What do Banks Look At When Lending?
Different Banks and financial institutions have policies that influence the rates they offer. These criteria can include internal risk assessment policies, target markets, and the cost at which the banks themselves get money.
A bank with a strategy focused on business growth might offer lower interest rates to attract more customers. On the other hand, if a Bank’s funding costs increase due to market volatility, it might need to adjust its interest rates upwards to maintain its profit margins.
The Impact of Your Business Type and Sector
The industry in which a business operates and its market stability can heavily impact the interest rates it might incur. Generally, sectors considered stable, such as IT or healthcare, might enjoy lower rates than volatile fields like hospitality or real estate.
For instance, a technology firm might secure a loan at 12% interest, whereas a restaurant in the hospitality industry might face a rate of 16% due to higher perceived operational risks. Similarly, older, more established businesses with steady revenue streams are often viewed as less risky, giving them the edge to negotiate better rates than newer enterprises.
Government Support and Loan Costs
Government policies fostering small and medium enterprises can significantly influence interest rates. Programs that offer subsidised rates or government-backed guarantees can reduce borrowing costs.
Under specific schemes, SMEs might avail loans at a subsidised rate of 10% to promote entrepreneurship. Additionally, loans backed by government guarantees might be seen as lower risk, which can reduce interest rates by 2-3% compared to standard rates, making such options highly attractive for eligible businesses.
Conclusion
The factors influencing Business Loan interest rates are complex and interlinked, touching on aspects of the broader economy, individual business circumstances, lender-specific criteria, and government policies. By understanding these factors, business owners can better prepare and possibly secure more favourable loan terms.
Also Read: Decoding the factors that influence business loan interest rates
