MSME Business Loan Interest Rates in India: A Complete Guide

Learning About MSME Business Loan Interest Rates

An MSME loan interest rate is the percentage a lender charges on the principal loan amount as interest for lending the loan. It is the borrowing cost and is often applied per annum as the Annual Percentage Rate (APR). A lower interest rate decreases the repayment burden, while a higher interest rate increases the financial strain of borrowing.

Types of Interest Rates

There are two simple types of interest rates in MSME loans:

• Fixed Interest Rate – The rate of interest remains constant during the loan term, and monthly repayments stay constant throughout the loan term. This option is stable and best suits firms that prefer uniform repayment amounts.
• Floating Interest Rate – The interest rate varies with market rates and RBI action. While this option can lead to lower initial rates, firms must prepare for higher repayment figures when the interest rates go up.

Key Factors Determining MSME Business Loan Interest Rates

The lender takes into account several factors before choosing an MSME business loan interest rate. These parameters allow banks to ascertain the risk of lending to a firm.

CIBIL Score

CIBIL score is a crucial determinant of creditworthiness. Lenders heavily rely on this score to assess the risk associated with lending to an MSME. A strong CIBIL score significantly increases the chances of securing lower interest rates.

Key factors that lenders consider when assessing whether to offer credit are:

• Repayment history: Default or delayed payments can lower the credit score, increasing interest rates
• Credit utilisation: Firms with high utilisation of their credit limit can be regarded as financially stressed
• Active debt obligations: High-active loans can lower the creditworthiness of a firm because there will be existing repayment obligations

Business Vintage and Financial Performance

Lenders prefer companies that have a strong operational track record. MSMEs with at least three years of operating experience and steady revenue growth are generally offered loans at better rates.

Factors considered by lenders include:

• Annual revenue and profit margins: Good revenues and profits indicate a sound business with less lending risk.
• Tax returns and audited account: Proper documentation of revenues, expenses, and tax returns provides credibility.
• Stability and growth pattern: Companies with consistent growth are more likely to be given low interest rates.

Collateral or Security

MSME loans can be categorised as secured (collateral-based) or unsecured (no collateral). The rate of interest is directly affected by the type of loan.

• Secured Loans: Secured loans are secured by assets such as property, equipment, or inventory. Lower interest rates are offered as lenders incur less risk due to the collateral.
• Unsecured Loans: As no security is offered, lenders levy higher interest to account for the risk. Approval generally relies on the business performance and creditworthiness.

Market Conditions and RBI Policies

Loan interest rates in all banks and financial institutions are based on economic conditions and RBI policies.

• Repo Rate Changes: RBI lowers repo rates (rate at which it lends to commercial banks) to manage inflation and liquidity. If the repo rate is lowered, MSME business loan interest loan rates come down, making loans more affordable. Similarly, when the repo rate increases, borrowing becomes more expensive due to higher interest rates.
• Inflation and Market Liquidity: Lenders provide competitive interest rates during economic stability because of lower risk when the inflation is lower. In periods of financial crisis or inflation, interest rates rise in response to increased risk.
• Government Schemes: Government programs such as MUDRA, CGTMSE, and Stand-Up India typically provide subsidised or reduced interest rates for MSMEs, ensuring wider accessibility at lower interest rates.

Types of Lenders Offering MSME Loans

MSMEs have different sources of funding, each with a different interest rate based on risk assessment, operating costs, and regulatory requirements. The lender determines the cost of borrowing and loan terms. Here is a comparison of interest rates between different lenders.

Public Sector Banks

Public sector banks (PSBs) generally have the lowest interest rates on MSME loans due to government support and lower operational costs. The banks favour financial inclusion and provide subsidised rates under different schemes. MSMEs with good financial reports and high credit ratings may get approved for lower interest rates. However, loan processing with PSBs may be time-consuming and bureaucratic.

Private Banks

Private banks provide MSME loans at a marginally higher rate than PSBs but with quicker approvals and more flexible repayment terms. They cater to startups and established firms, making them a popular choice among companies with shorter business histories. Private banks may charge more interest than PSBs but offer improved customer service and faster funding, making them ideal for companies requiring quick capital.

NBFCs (Non-Banking Financial Companies)

NBFCs provide more flexibility compared to conventional banks. They address the needs of enterprises that are likely to be ineligible for bank financing because of lesser credit ratings or the absence of security. NBFCs are more suitable for firms requiring instant funding. However, borrowers must employ caution because NBFC loans may often involve higher borrowing costs.

Fintech Lenders

Fintech firms use technology-enabled platforms to provide quick MSME loans with minimal paperwork. They determine creditworthiness using alternative data such as transaction data and business cash flow. Fintech lending is ideal for MSMEs requiring small-ticket, short-duration funding, although companies need to consider the increased interest expenses.

Government-Backed Loan Schemes

The Indian government offers various loan schemes for MSMEs, usually at subsidised interest rates and lenient eligibility standards. These schemes typically offer lower interest rates due to government subsidies. It is suitable for MSMEs looking for low-cost financing, but the businesses must fulfil certain eligibility standards.

How to Get Competitive Interest Rates on MSME Loans

Getting the ideal MSME business loan interest rate involves proper planning and informed decision-making. Here’s how you can increase your chances:

• Enhance Credit Profile and Finances: Timely payment of bills, paying off debts, and low credit utilisation percentage can increase creditworthiness, boost credit rating.

• Select Suitable Lender and Product: You can compare interest rates and terms across public sector banks, private banks, NBFCs, and fintech lenders to find the most competitive rate that aligns with your business needs.

• Negotiate for Better Rates: You can leverage a high credit rating, solid finances, and collateral to negotiate favourable loan terms.

• Tap into Government Schemes and Subsidies: Use MUDRA loans, SIDBI schemes, and credit guarantee programs for more affordable financing.

Key Takeaways

MSME interest rates on loans affect borrowing costs and profitability. Lenders evaluate credit scores, company history, loan terms, and collateral while fixing loan interest rates. While government banks have lower rates, you may have to deal with delayed approvals. Private banks, NBFCs, and fintech lenders offer quicker access but at higher rates. Government programs provide low-cost credit with eligibility conditions. To secure better loan terms, MSMEs must boost their credit score, select the right lender, negotiate, and seek subsidies. Prudent financial planning assists in cost-saving funding and long-term development.

(No Hans India Journalist was involved in creation of this content)