Which is Better for Business Loans – Banks or NBFC?

Bank or NBFC for Business Loan Overview

As a business owner, your reliance on loans from banks is quite understood as the business goes through several ups and downs. There would be very few businesses which can withstand unpredictable business cycles and manage headwinds without worrying about any business loan. For those who are unable to scale up because of crunch in the capital always turn to loan from banks. Today markets have opened up and the government has also supported SMEs through various schemes and loans. There are a plethora of options available if you want to apply for a business loan. Of all the choices available you usually get stuck between a bank and NBFC. Here we demystify both the financial institutions which can help you make an informed decision for your business.

It is important to have clarity on the two financial intermediaries in any financial system. NBFC is primarily Non-Banking Finance Company that provides banking services without holding a banking license or any legal agreement. NBFCs have to get registered under the Companies Act 1956 to offer services similar to banks. NBFCs are privately owned institutions regulated by the RBI and other government entities.

While a bank is a financial institution that accepts deposits from the public and creates credit. Banks can perform lending activities either directly or indirectly through capital markets.

Banks can manage financial services and products generally authorized to them. Most importantly banks can accept demand deposits while NBFCs can only lend or invest but they are not allowed to accept demand deposits.  A demand deposit is a bank account which allows the account holder to withdraw his money from the account at his will and by any means without notice to the bank.

The functions of NBFCs are limited to the extent that they can accept/renew public deposits for a minimum period of 1 year to 5 years. The maximum interest rate an NBFC can offer is 12.5%. Also, keep in mind that the RBI doesn’t guarantee the repayment of deposits by NBFCs, unlike banks. Since NBFCs doesn’t form a part of the payment and settlement system, it cannot issue a cheque to its customers.

In fact, both institutions offer attractive deals to customers with different needs of borrowings. NBFCs are typically divided into three categories –Asset, Loan and Investment Companies.

In recent times Indian banks’ are struggling with bad loans which has given way to NBFCs which are not as strictly regulated as banks. Access to formal credit is still a big challenge to MSMEs, with nearly 40% of lending taking place through informal sources, according to report by the Omidyar Network and BCG. To avail a small business loan, NBFCs can offer a better deal than traditional banks. Here are some of the reasons.

Interest rates

Bank loans are typically linked to the MCLR, the minimum interest rate below which a bank is not permitted to lend. It is further linked to macro-economic factors such as RBI lending rates, international market, etc. On the other hand, NBFCs offer loans  based on the prime lending rate (PLR) which is not regulated by RBI.  As a result, NBFCs can exercise some amount of freedom to increase or decrease loan rates as per their requirements. It benefits the customers and offers them multiple options, especially when they can’t meet the loan eligibility criteria of banks.  NBFCs get an edge over banks who can’t lend below MCLR slab. It is seen that cases, where owners easily meet the criteria may end up paying higher interest rates compared to a loan from banks.

Loan eligibility

The eligibility of a loan can differ between a bank and NBFC. Since it is not regulated as tightly as banks, NBFCs can sanction amount higher than banks. Also, most banks don’t fund the entire credit requirement and fund only a certain portion and the rest has to be paid by the borrower. However, NBFCs can find out ways to help borrowers and sanction the entire business loan. While some NBFCs offer business loans with a loan limit that is pre-approved, which means if you are a business owner you can withdraw funds from your pre-approved loan limit. The most interesting factor is that businesses will be paying interest only on the used amount and not on the entire loan amount, unlike the term loans, where EMIs are on the entire amount. The interest is charged only on the amount utilized which can help in reducing the monthly business loan EMIs. Such pre-approved loan limit comes to the rescue of business and ensures they are never devoid of capital. Moreover, there is no need to apply for multiple applications for procuring loan at any point in time.

Paperwork

NBFCs have a good share of small business loans in their books because of the above reasons. Most people turn towards business loan from NBFCs because of less documentation and paperwork while banks can be stringent when it comes to approval of the documents. If you are unable to provide requisite documents, banks may not process the loan and refuse the application. However, NBFCs have minimum documentation and the business loans are processed much faster than a bank.

Credit Score

Banks follow strict guidelines and ensure that the borrower has a good credit score because business with a poor credit score is deemed risky. NBFCs may offer and accept SME business loan even if the credit score is not too good. However, keep in mind in such a scenario you may have to pay a higher interest rate to balance out the default risk. As the capital need is of prime importance for small business it is imperative that you evaluate all the options available. In 2017, the Reserve Bank of India in its financial stability report found that the NBFCs are more successful than banks and their balance sheet expanded 15.5%.

Both lending institutions have their pros and cons. As a business owner, you should carefully read the offer documents, calculate EMIs with the help of business loan calculator and consider the benefits mentioned above before approaching to either of the two for a small business loan.

Advantages of NBFCs

Private non-banking financial companies in India have grown in popularity due to their flexible services and customer-friendly approach. Here’s a closer look at what NBFCs loan offer:

• Inclusive Loan Access: NBFCs provide more accessible loan options, especially for individuals with lower credit scores or informal incomes. With their simplified application process, diverse borrower profiles can gain funding more readily. 

• Cost-Effective Solutions: Thanks to lower operational costs, NBFCs often offer competitive rates and tailored repayment schedules, allowing businesses to manage loans more efficiently. 

• Less Stringent Credit History Requirements: NBFCs are typically more flexible regarding past credit issues. They allow borrowers with a limited or mixed credit history to still qualify for a loan. This flexibility makes them a lifeline for businesses in need of financial rehabilitation. 

• Diversified and Specialised Services: Private NBFCs offer specialised NBFC business loans targeting specific markets, such as loans for MSMEs, housing finance, and vehicle loans. This expertise allows them to better meet the financial needs of their customers. 

• Financial Inclusion: NBFCs play an essential role in promoting financial inclusion, particularly in underserved or rural areas. By leveraging technology like mobile apps and digital verification, they make financial services accessible to a larger population, bridging the gap between the formal and informal financial sectors. 

• Quick Disbursement of Funds: Besides faster approval times, NBFCs can often disburse funds more quickly than banks. This speed is valuable for businesses needing immediate cash flow solutions to handle unexpected expenses or seize growth opportunities. 

• Enhanced Privacy and Confidentiality: Private NBFCs often maintain a more personalised approach, offering greater discretion in handling client information, which can appeal to clients prioritising confidentiality. 

• Seamless Digital Experience: Many NBFCs focus on streamlining their online platforms, making it easier for users to apply for loans and manage accounts digitally. This digital-first approach is particularly advantageous for busy entrepreneurs who prefer loans with efficient online services over in-person bank visits. 

Difference Between Banks and NBFC

NBFC Business Loan is Good or Bad?

An NBFC business loan can be a good option depending on your needs and circumstances. Here are some advantages to consider: 

• Flexible Eligibility: NBFC business loan providers tend to have less strict eligibility requirements. This flexibility benefits businesses with lower credit scores or non-standard income streams, which may struggle to qualify for bank loans. 
• No Collateral Requirement: Many NBFCs offer unsecured loans, meaning they don’t require physical collateral. This feature appeals to startups and small businesses without substantial assets to pledge. 

• Customised Products: NBFCs often provide specialised loan products to different business needs, like working capital, machinery loans, or MSME funding. 

• Faster Approval: Compared to traditional banks, NBFCs have shorter processing times and reduced documentation needs. This quicker turnaround can be advantageous for businesses that need rapid access to funds. 

• Flexible Repayment Plans: NBFCs may offer more adaptable repayment terms, which helps small businesses better manage cash flow. 

However, NBFCs may charge higher interest rates, especially if your credit score is low, as they absorb more risk when lending without collateral. It is wise to evaluate your financial situation and business goals before opting for a business loan. 

Conclusion

Both banks and NBFCs have distinct advantages when it comes to business loans. Banks may offer lower interest rates and higher regulatory security, while NBFCs provide flexible eligibility and faster processing, ideal for businesses needing quick funding. Choosing between them depends on your specific business needs and credit profile. For reliable support with business loans, the Lendingkart helpline number is always available to assist with any queries. 

FAQs:

1. What is the Difference Between Getting a Business Loan from a Bank and an NBFC?

The primary difference between getting a business loan from a bank and an NBFC (Non-Banking Financial Company) lies in their lending practices. Banks are traditional financial institutions regulated by central authorities, offering relatively lower interest rates and stricter eligibility criteria. In contrast, NBFCs are more flexible, with quicker approvals but higher interest rates. The choice between banks and NBFCs for a business loan depends on individual needs, financial standing, and the urgency of funding.

2. How Do I Determine Whether to Approach a Bank or an NBFC for a Business Loan?

When deciding between a bank and an NBFC for a business loan, consider your specific needs and qualifications. Banks typically offer lower interest rates and are ideal for well-established businesses with strong credit. NBFCs are more flexible and suitable for businesses with less credit history. Evaluate your requirements, financial health, and the speed of approval to make an informed choice.

3. What Documents and Information Do I Need to Apply for a Business Loan from a Bank or NBFC?

To apply for a business loan from a bank or NBFC, you’ll typically need documents such as your business plan, financial statements, tax returns, KYC documents, and collateral details. The key difference between banks and NBFCs is that banks are regulated financial institutions, while NBFCs are non-banking financial companies. The choice between them depends on your specific needs, as banks often have stricter requirements, but may offer lower interest rates, whereas NBFCs may provide faster approval with more flexible terms. Consider your business’s unique circumstances when deciding.

4. Are Interest Rates Higher with NBFCs Compared to Banks?

Interest rates offered by Non-Banking Financial Companies (NBFCs) tend to be slightly higher than those of traditional banks. NBFCs often serve riskier markets, making them impose higher interest rates to mitigate potential losses. For business loans, the choice between banks and NBFCs depends on individual circumstances; banks are generally more cost-effective, while NBFCs can be more accessible for businesses with weaker credit profiles.