Why Do SME Loans See Steeper Rate Hikes Than Corporate Borrowing?

Rajesh owns a small clothing business in Jaisalmer. He recently borrowed ₹80 lakh at 14.2% interest for working capital.

Around the same time, a listed company raised ₹500 crore through a bank loan at just 8.6%.

You can see that Rajesh borrowed a much smaller amount than the listed company, yet his interest was almost double. This is not a single case; many small businesses face the same situation. 

If you are also facing the same situation, keep reading this blog to learn why SMEs end up paying more interest than big corporations.

Limited Credit History

If you own an SME, you must know that they generally don’t have a long borrowing record. Their credit score (if available) lies between 650 and 720. 

Most SMEs are first-time borrowers, and many lenders and banks see this as risky. However, they increase the rate of interest to protect themselves from any future mishaps.

Let’s look at the credit comparison between SME and Corporate:

Higher Operational Cost For Lenders

A bank spends almost the same time and resources processing a ₹100 crore corporate loan as it does processing a ₹1 crore SME loan. 

However, banks receive much lower returns from SMEs. Therefore, lenders charge higher interest rates to recover that cost.

Collateral Shortage Increases Rates

Most SMEs seek out loans without offering any security, which makes their loans unsecured. To protect themselves from such high risk, lenders charge more interest. 

Large corporate firms provide collateral such as property, shares, or machinery, which builds the bank's trust.

Let’s have a look at the comparison between a secured and an unsecured loan:

SMEs Have Less Bargaining Power

We all know a common negotiation rule: the bigger the ask, the more you can negotiate. 

A company asking for ₹100 crore loan has better chances of negotiation. In comparison to a small business asking for ₹25 lakh or ₹50 lakh.

Informal Records And Poor Documentation

Many small business owners like you, prefer to keep handwritten ledgers or simple Excel sheets. They do not use accounting software or digital tools. 

Such informal records are not trusted documents that can be used to apply for a loan.

Recently, Mahesh, owner of a Chandigarh-based SME, applied for a ₹60 lakh loan. He used to under-report his income to reduce tax liability.

On paper, his annual turnover was ₹40 lakh. However, in reality, he makes over ₹1 crore in sales.

When he applied for a loan bank only approved ₹25 lakh at 15% interest. This rate is far above the average corporate loan rate.

His proper documentation and transparent records would have helped in getting better loan terms.

Why Rate Cuts Don’t Help Small Businesses Quickly?

When the repo rate is decreased by the RBI, large borrowers get benefits from it quickly. However, for SMEs it takes time.

Generally, loans provided to SMEs are fixed-rate or revised only twice a year. This delays the advantage.

Dependence On Informal Lenders

Still, nearly 40% of SMEs are dependent on informal money lenders for loans. They charge a very high rate of interest from them, sometimes over 20%.

It clearly shows how difficult it is for them to get affordable loans. Such conditions push mostly SMEs into a cycle of high-cost borrowing.

Let’s look at the lending sources for SMEs:

Final Thoughts

Small and medium businesses are important for our country. As it helps in providing jobs, local development, and economic growth.

Still, they have to face more challenges in comparison to a corporation when trying to secure a loan.

Banks mostly charge a high rate of interest from SMEs due to structural issues such as no security, weaker credit history, limited paperwork, and many more.

If you will be able to improve financial discipline and adopt better practices for your small business, then you can bridge the gap in borrowing cost. 

FAQs

1. I own a small business. Can I get a loan without collateral?

Yes, but you might have to pay a higher rate of interest.

2. Who lends to SMEs apart from banks?

NBFCs, FinTechs, and sometimes informal money lenders.

3. Is there any scheme available to help reduce SME loan interest?

Yes, government schemes like CGTMSE provide support through guarantees.

4. Do better GST filings help in loan approval?

Yes, it builds trust with lenders and improves chances.

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About the Author

LoansJagat Team

We are a team of writers, editors, and proofreaders with 15+ years of experience in the finance field. We are your personal finance gurus! But, we will explain everything in simplified language. Our aim is to make personal and business finance easier for you. While we help you upgrade your financial knowledge, why don't you read some of our blogs?