The demand and supply of business loans rest on several factors: the interest rate, loan term restrictions such as collaterals and life of the loan, and, most importantly, the economic outlook of the country.
When the economy grows, the demand for business loans increases as the firms look to take advantage of the increased opportunities. The enhanced demand also stems from the fact that the lenders are more amenable to provide loans at agreeable terms.
During economic slowdowns, there is concern over potential losses among lenders, and they provide loans at much more stringent terms. Business owners, especially small business owners, find it very hard to get business loans in India in favorable conditions.
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Demand & Supply for Business loans in India
If a business, whether large or small, has a project in hand with the potential to fulfill its profit requirements, it will consider external funding options such as business loans. The lenders examine the company’s return projections and potential risks.
They compare the borrower’s proposal against other propositions. Few big companies weigh the debt amount against selling an equity stake, while some offer real estate or vehicles as collateral.
As stated above, businesses undertake projects that are risk-adjusted and hold potential for high returns. The higher the number of such profitable projects, the stronger the desire will be of the company to seek business loans.
One can safely surmise that a business with numerous projects that promise high returns after sufficient risk assessment, will be keener to get business loans than the company with comparatively fewer projects.
When economic growth is on an upward trajectory, businesses will find more profitable projects. When the trajectory of economic growth starts sinking, the probability of getting more projects go down as well. As the economy of the country swings, the demand and supply for business loans change as well.
Major Economic Factors that affect Business Loans
While each factor has been briefly explained independently here, please note that each element listed below are intertwined with each other.
1. Monetary policy of the country
India’s monetary policy is determined by its central bank, the Reserve Bank of India (RBI). RBI uses several tools that are at its disposal to regulate the supply of capital in the market. The policy that RBI sets up has a massive bearing on the state of loans in India.
If the economic growth is stable with adequate liquidity, then the interest rates on loans are lower. Note that the monetary policy is implemented based on the current financial health and the state of inflation in the country.
2. Interest rate changes
One factor that significantly affects the demand and supply of business loans is the prevailing interest rates in the market. High interest rates hamper the rate of economic growth of the country.
A higher interest rate means a rise in interest payments which discourages the borrowers from applying for business loans. When the economy is steady, and interest rates are low, business owners are motivated to avail business loans.
RBI slashed the interest rate by 25 bps to 5.15% during its recent October meeting in order to combat slow economic growth.
Inflation denotes the rate at which the price of goods and services increases in a country. It lets entrepreneurs know whether doing business in the current economy will be expensive or cheaper for them.
When inflation in the economy escalates, the goods get more expensive, and it reduces the buying power of the individuals. The result is- higher interest rates and a decrease in demand for business loans. Inflation has a considerable effect on the prevailing interest rate and RBI’s monetary policy.
4. Economic slowdown
Economic slowdown puts brakes on the flow of money. The lack of cash flow results in an increased number of bankruptcies, especially for SMEs that require late-stage funding.
Too many bankruptcies discourage banks, venture capitalists, and other lenders from offering loans to small businesses until the economy turns around. As the economy slows down, lending to businesses (including SMEs) declines. Business loans tend to pick up as the economy recovers.
5. Players that influence the economy
Several segments drive the economy of a country. These segments are banks, enterprises, stock markets, financial institutions, lenders, and borrowers (business and personal). All of them are interlinked with one another.
Any disruption with one segment has a ripple effect on all the other sectors as well. For instance, any disruption in the stock market could drive the interest rates high, which in turn could affect the state of business loans in India.
Impact of SMEs on the Economy
SMEs have gradually grown to become a crucial part of the Indian economy. These enterprises have not only contributed to the development of the nation’s economy but have also created more employment opportunities.
People who found it challenging to be employed in large organizations are now able to find jobs in these small businesses. The increased presence of SMEs led to a reduction in poverty and unemployment, thereby influencing the socio-economic growth of the country.
According to a KPMG report that was released in February 2019, the number of start-ups has grown from 7000 in 2008 to 50,000 in 2018. The numbers are expected to grow further in the coming years. As the influence of these start-ups has grown, the government, as well as the financial players in the private sector, have recognized the value of these small businesses.
While it was difficult for small companies to gain funds a decade ago, things have changed now, and there are several support systems set in place to support the budding entrepreneurs.
Impact of Economic Fluctuations on Small Business Loans
Economic changes significantly influence small business lending and borrowing as follows:
- Lenders are risk-averse based on the general economic state of the nation. During slowdowns, they are highly risk-averse and could decline to make business loads that they would have agreed at other times.
- Small businesses may decline to undertake projects that provide risk-adjustment returns during slowdowns. This practice reduces the demand for small business loans.
- The economic fluctuation affects the collateral values as well. For instance, the collateral value of a real estate may be low during the slowdown period as compared to the time when the economy is healthy.
The above points validate how economic prominence has a significant impact on business loans in India. If you have additional insights to add, please share them in the comments below.
If you want to safeguard yourself from the economic fluctuations while securing a business loan in the future, then talk to our experts at Indifi. Indifi is a customer-centric online lending platform supporting businesses in more than 200 cities across India.