To boost MSME (Micro, Small and Medium Enterprises) sector in the country, many banks and financial institutions have introduced various loan schemes for MSMEs. Many such lenders also offer special incentives to MSMEs because of their limited access to credit and higher risk profile associated with this segment. However, most of these loans come with caveats that restrict the borrower from using them in a certain way. Some banks offer interest-free loans to MSMEs on the condition that they cannot charge their customers an interest rate above a fixed threshold. These special conditions restrict the borrower’s ability to expand its business by limiting it monetization methods while also forcing the borrower pay back more money than it would otherwise if it had unrestricted access to capital markets. The following section takes a look at some of these conditions in brief.
Why MSMEs Need Interest-Free Loans?
MSMEs are critical to the Indian economy because they account for more than 40 percent of GDP and employ more than 90 percent of the country’s workforce. Yet, they face a number of challenges such as access to finance, limited operating scalability, and high working capital requirements. MSMEs in India are typically family-owned businesses that lack access to formal credit and are largely dependent on informal sources of credit such as personal savings, internal accruals, and loans from commercial or cooperative banks. MSMEs operate in the informal sector, so they do not have the ability to issue debt and equity in the formal capital market. Instead, they depend on banks and non-banking financial companies (NBFCs) for term loans that can be repaid over a period of time.
Repayment conditions in MSME loan
One of the most common conditions in an MSME loan is that the borrower must pay back the interest amount to the lender. This condition is the same for almost all loans and is not specific to MSMEs. However, the lender may also have other conditions such as the borrower’s need to have collateral. Depending on the lender, the MSME may have to pledge movable assets like inventory, equipment, or machinery, or immovable assets such as real estate, land, etc., to secure the loan. In some cases, the lender may ask the borrower to provide a personal guarantee that commits the borrower to pay back the loan if the business fails to do so. The difference between a normal loan and an interest-free loan for an MSME lies in the amount of time the borrower has to pay back the amount.
Zero-Interest Loan With a Fixed Return
A lender may provide an MSME a zero-interest loan but the borrower has to return a fixed amount of money to the lender. This arrangement is very similar to a normal loan, except it is interest free. The amount that the borrower has to pay back can be fixed or vary based on, for example, the performance of the business. For example, a lender may provide an MSME with a loan that has zero interest if the borrower agrees to give the lender 30 percent of any profit made by the business.
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Zero Interest Loan With a Fixed Maturity Date
A lender may provide an MSME a zero-interest loan with a maturity date. This type of loan is sometimes called an interest-free loan with a fixed maturity date. The lender may give the MSME the money it needs to conduct its business operations, but with a fixed date to pay back the amount. The amount of time the lender gives the MSME to pay back the loan may vary from a few months to as long as five years. The borrower may have to pay back the entire amount or a portion of it depending on the terms of the contract that the borrower signs with the lender.
Zero Interest Loan With a Fixed Repayment Period
A lender may provide an interest-free loan with a fixed repayment period. This type of loan is similar to a zero-interest loan with a fixed maturity date. The lender gives the MSME the money it needs to conduct its business operations, but the MSME has to pay back the amount in a set period of time. The amount of time the borrower has to pay back the loan may vary depending on the lender. This type of loan may be beneficial to an MSME that needs a certain amount of capital but only needs it for a certain time period.
Zero interest loan with restriction on usage
A lender may provide an MSME an interest-free loan, but place certain restrictions on how the borrower can use the money. Some lenders offer this type of loan to MSMEs to encourage them to grow their businesses without charging the customers interest. These lenders may offer interest-free loans to MSMEs on the condition that the borrower does not charge their customers interest. Some lenders require the borrower to pay back the amount of the loan along with a fixed rate of return. This is similar to the zero-interest loan with a fixed return, except it applies only to interest and not the principal as well.
Conclusion
MSMEs are critical to the Indian economy because they account for more than 40 percent of GDP and employ more than 90 percent of the country’s workforce. However, they face a number of challenges such as access to finance, limited operating scalability, and high working capital requirements. Banks and financial institutions have responded to this problem by offering various loan schemes for MSMEs. Many such lenders also offer special incentives to MSMEs because of their limited access to credit and higher risk profile associated with this segment. MSMEs can benefit from these schemes, but they must be aware of the terms and conditions associated with these loans. Some banks offer interest-free loans to MSMEs on the condition that they cannot charge their customers an interest rate above a fixed threshold. These special conditions restrict the borrower’s ability to expand its business by limiting it monetization methods while also forcing the borrower to pay back more money than it would otherwise if it had unrestricted access to capital markets.