Banks or NBFCs: Which Is Better for Business Loan?

. 7 min read
Banks or NBFCs: Which Is Better for Business Loan?

A business loan is the lifeblood of any business establishment. Especially in these times of COVID-19, loans play an integral part in the functioning of business concerns. As per the Borrower Pulse report released by IndiaLends, approximately 25% of the borrowers opted for a personal loan to start their business venture. The survey was conducted among borrowers in Tiers I and II cities in India from March 2020 to March 2021. However, while applying for a business loan, the business owners in India often face the dilemma of which alternative to choose from. The two primary options are either to go for bank loans for business concerns or apply for an NBFC business loan (the one offered by a non-banking financial company). In this article, we will explore in detail the pros and cons of both these avenues.

Top 5 Benefits of NBFCs In Comparison to Banks

1. Less Paperwork and Documentation

In India, the Reserve Bank of India (RBI) regulates the banking system. Hence, the rules for banks are much more stringent than NBFCs. With banks, if you fail to produce the necessary documents they may not proceed with your loan application. Resultantly, there are higher chances that your loan application may face ejection. Conversely, the documentation and paperwork involved in applying for a loan from an NBFC are much less than that of a bank. Thus, there is a sharp rise in the number of loan applicants who opt for an NBFC business loan. The report by Boston Consulting Group shows that from 2014 to 2017, the share of NBFCs in total loans shot up from 21% to 44%.

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2. A Lower Credit Score Not To Affect Your Prospects

While evaluating the applications for business loans, banks ensure that the loan applicant is having a good credit score. Due to the strict rules and regulations followed by banks, it is considered risky to advance loans to those with a poor credit score. When it comes to NBFCs, they just do not rely only on the credit score for loan approval as in the case of banks. They have their own credit evaluation system and consider several other factors as well. The NBFCs follow a holistic approach and check various factors such as the nature of business, the number of years of experience in the same business, turnover, bank statements, and Income Tax returns filed in the last 2–3 years to evaluate the creditworthiness of the borrower. Hence, even if your credit score is poor, you still have a strong chance of getting the loan sanctioned from an NBFC. However, in such situations, you may end up paying a higher interest rate for balancing out the default risk.

3. Lower Interest Rates

The interest rate charged on loans is quite critical for business establishments. However, the most shocking part is that many of the borrowers are unaware of the interest element. The study conducted by Home Credit India in 7 cities indicates that 76% of the borrowers are unaware of the interest amount of their loans. As per the rules, banks are not permitted to lend below the marginal cost of the funds-based lending rate (MCLR), which is the minimum interest rate. It is also linked to various other macro-economic factors such as RBI lending rates, developments in the international market, etc. In the case of NBFCs, they offer loans based on the prime lending rate (PLR). Unlike banks, there is more flexibility to increase or decrease the interest rates. Hence, the NBFC business loan interest rates are quite competitive in comparison with banks.

4. Loan Eligibility Varies

In the case of NBFCs, they can approve higher loan amounts when compared to banks. Another drawback of the majority of the banks is that they do not sanction the entire credit requirement of the loan applicants. The banks fund only a certain part and the remaining amount has to be paid by the borrower. However, NBFCs can sanction the whole amount of business loans. Some of the NBFCs provide business loans where the loan limit is pre-approved. In such cases, the entrepreneurs can withdraw the amounts from the pre-approved loan limit. The best part of this system is that as a business owner you need to pay interest only for the amount used and not for the full loan amount. Conversely, when you opt for term loans, you have to pay equated monthly instalments (EMIs) for the entire amount. Thus, the pre-approved loan limit comes as a boon for business owners and ensures that they never run short of capital. Further, it eliminates the need of applying for multiple loan applications for obtaining loans.

5. Faster Processing of Loans

In many cases, entrepreneurs apply for a business loan when they are in urgent need of funds. Due to the strict rules imposed by banks, it involves delays to get the loan sanctioned. NBFCs work out to be more beneficial in such scenarios as the loan processing is simpler, quicker, and seamless. Thus, in such situations, even if the interest rates are higher, borrowers prefer to go for a NBFC business loan.

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For managing the day-to-day operations of a business enterprise, it’s essential to take a business loan. Especially in these times of COVID-19, business concerns are facing tough times due to the challenges posed by the pandemic. Hence, the banks and other financial institutions aggressively market their business loan products among customers. However, NBFCs clearly score over banks due to the various reasons discussed above. It ranges from flexibility, easier loan processing, and not taking credit scores into account. Therefore, the majority of the business owners prefer to go for an NBFC business loan over banks.

Also read:

1) What is a business loan? How to apply for a business loan?
2) Home Loan: Steps to apply, Best Interest Rates on Home Loans & more
3) What is Business Loan? A Complete Guide.
4) How To Get Small Business Loan From Government?

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Q. What are the eligibility criteria for applying for a business loan?

Ans. The business concern should be making profits for the last two years. The minimum annual income of the firm should be Rs. 1, 50,000 per year. During the time of applying for the loan, the age of the applicant should be at least 21 years. At the time of maturity of the loan, the applicant should not be more than 65 years.

Q. What is the minimum bank balance I need to possess while applying for a business loan?

Ans. If you are applying for a business loan with no collateral, the majority of the banks and NBFCs look for a minimal annual turnover of Rs. 1 crore. However, some of the banks and NBFCs also offer loans to businesses or self-employed whose turnover is below Rs. 10 lakhs as well.

Q. What is the minimum CIBIL score required for a business loan?

Ans. Generally, you need to have a CIBIL score of at least 750. However, in the case of business loans, the best CIBIL score would be somewhere close to 900.

Q. What are Flexi business loans?

Ans. They are new-age loans where the applicant will be provided with a loan limit. It comes with the flexibility of using as and when required. With these loans, you can utilise the funds for various purposes such as buying equipment, expansion of business, capital crunch, and employee training.

Q. Who is eligible for a Mudra loan?

Ans. Anybody running a small business enterprise is eligible to apply for a Mudra loan. The Mudra loans are divided into three categories. The first category is Shishu where loans up to Rs. 50,000 are offered. The second category known as Kishor covers loans between Rs. 50,000 and Rs. 5,00,000. The last category Tarun offers loans in amounts ranging between Rs. 5,00,000 and Rs. 10,00,000. Shishu is meant for extremely small business units, Kishore for slightly bigger businesses, and Tarun for big businesses. For women entrepreneurs, Mudra offers a special refinance scheme termed as Mahila Uddyami Scheme.