MSME credit: 5 key reasons why NBFCs charge higher interest rates

Credit and Finance for MSMEs: NBFCs have become a pivotal part of the Indian financial system meeting the needs of individuals and SMEs. It accounts for around 9 per cent of total assets of the financial sector, making it the third-largest segment after commercial banks and insurance companies.


Credit and Finance for MSMEs: NBFCs are increasingly now preferred by borrowers as they not only complement but also substitute banks in their ability to reach remote areas, making quicker decisions, prompt services, and expertise in niche segments. They act as backup institutions when the banking system comes under stress by widening the ambit of financial services and enhancing its resilience. However, this sector calls for regulatory vigil and control on lending rates to thrive economically and provide an architecture to support the financial needs of growing small and medium scale businesses.


Considering the nature of the operation, NBFCs also bear the burden of inherent risks which includes, excess leverage, stripping priority lending sector status from bank to NBFCs, over-reliance on wholesale funding from capital-market or banks, vulnerability to credit risks, inadequate statutory recovery tools, and insufficient benefit from the central banks and amplification of procyclicality. The challenges encountered by NBFCs are several but the Reserve Bank of India (RBI) has looked into the challenges and made some measurable decisions for

non-banking institutions.

with those of banks, NBFCs have been divided into four layers based on their activity, size, perceived risk, and scale- based regulations to help preserve financial stability. The base layer with asset size below Rs 1,000 crore, middle layer with asset size 1,000 crore and above, and an upper layer including top ten NBFC in terms of asset size. Along with that, RBI has also tweaked the NPA classification for NBFCs to 90 days from 180 days and the net-owned fund’s requirement for these NBFcs have been raised to Rs 20 crore from Rs 2 crore which in turn reduces the stress of credit risk and maintaining sufficient liquidity for a smooth transition during the moratorium.


Despite easy accessibility, maximum funding, The operations of NBFCs are regulated by the Reserve Bank of India Act, 1934 with priority given to calibrating regulations and harmonizing them to banking sector regulation thereby reducing the regulatory arbitrage. As per the new regulations to bring regulatory parity remote coverage, and improved regulations, NBFCs face a setback of charging a higher rate of interest and processing fees than banks due to its easier and convenient financing options. However, they cannot offer interest rates higher than the ceiling rate given by RBI. The present ceiling rate is 12.5 per cent per annum. Following are the reasons for higher loan interest rates by NBFCs:

Fundraising: Unlike?banks, NBFCs do not have a banking license and are not permitted to accept deposits from the public. They, therefore, have to raise funds through various sources like bank borrowings as term loans and also from FDI by selling commercial papers or six-month debt papers. Thus, the interest rate by NBFC has to cover their borrowing cost and the spread.