MSME businesses, individuals squeezed by high interest rates by private lenders

Borrowers face steep costs, public sector rates lower

With many of the smaller borrowers, be it businesses or individuals, squeezed out of the credit market, they face excessively high borrowing costs as their last recourse, private lenders, charge interest rates of up to 24 pc annually. While some analysts say that the high rates are due to higher risk posed by these borrowers, but operational costs and limited regulatory oversight are also responsible.

Every now and then social media and news agencies across India report about excessive interest rates being charged by private loan companies that push individual buyers and SMEs into a virtual debt trap.

These companies face criticism for charging exorbitant interest rates as some loans carry annual rates as high as 24 pc. Even though these rates are significantly higher than those provided by public sector banks, there are a number of intricate reasons and repercussions that touch on risk, regulation and financial inclusion.

Leading private banks like HDFC Bank, ICICI Bank and Kotak Mahindra Bank are providing personal loans with interest rates between 10.85 pc and 24 pc annually as of May 2025. Public sector behemoths like Union Bank and State Bank of India (SBI), on the other hand, provide rates that start at 10.30 pc and hardly ever go above 15.30 pc. The disparity goes beyond academics; for borrowers, it means thousands of rupees more in repayment.

Athar Raza, Officer, Economic Analysis at Infomerics Ratings, a credit rating agency, says that private lenders, particularly non-banking financial companies (NBFCs) and Microfinance Institutions (MFIs), charge significantly higher interest rates on personal loans than public sector banks due to a combination of structural constraints, elevated credit risks and market-driven pricing strategies.

“Nearly 90 pc of NBFC-issued personal loans were unsecured in 2023, exposing lenders to greater default risks due to the absence of collateral,” Raza tells Media India Group.

Rising interest rates on personal loans are impacting small business owners across India, forcing many to accept costly borrowing terms.

Ashish Kumar, a Jaipur-based sandstone factory owner, recently took a personal loan of INR 400,000 from a non-banking financial company (NBFC) at an interest rate of 22 pc per annum. “I needed urgent funds for a family emergency, and the process was quick, but the interest rate is shockingly high. My EMI is almost INR 11,000, and I will end up paying more than INR 160,000 in interest over three years,” Kumar tells Media India Group.

Private lenders in India consistently set higher interest rates than public sector banks, raising questions about the underlying factors driving this disparity.

“There are multiple reasons why private lenders charge a higher interest rate compared to public sector banks. In India, the vast majority of people work in the informal sector and a lot of them are self-employed. This makes such borrowers risky because there are higher chances that they might default. Public sector banks often refuse to provide loans to people they consider risky, but a private lender might be willing, charging a higher interest rate to offset the risk,” Vikas Verma, economist at the Centre for WTO Studies, Ministry of Commerce and Industry, tells Media India Group.

Verma adds that the profit motive is also at play, along with macroeconomic trends. “Banks might also charge a higher interest simply because they want to earn a higher profit. In the past few years, the Indian economy has been experiencing increased inflation. To control the inflation, the Reserve Bank of India (RBI) had increased their policy repo rate, which meant that the interest rate that banks charged also increased,” he says.

Operational challenges and funding constraints are significant factors influencing the interest rates charged by private lenders in the financial sector.

Raza notes that operational inefficiencies and higher funding costs also play a role. “NBFCs operate with operating expense ratios of 4.5-5 pc, compared to 2.5-3 pc for public sector banks (PSBs). They lack the low-cost capital access and sovereign backing available to public banks, making them more susceptible to funding cost volatility, especially during periods of inflation or RBI-led repo rate hikes,” he adds.

The impact of high interest rates extends beyond individual borrowers. Higher interest rates generally have a negative effect on the economy, as they reduce the investment and consumption rate.

“A higher interest rate makes loans expensive for consumers, companies and the government, so they might want to delay their expenditure and wait for the interest rates to go down,” Verma says.

Although the RBI and self-regulatory organisations have mechanisms in place to encourage responsible lending, both experts concur that enforcement is still difficult, particularly in the unorganised sector. By keeping their credit score high, providing collateral, or looking for a guarantor, borrowers can increase their creditworthiness.

“It is essential to approach the decision analytically, balancing immediate financial needs against long-term repayment capacity and risks. Taking on high-cost debt without a stable repayment plan can lead to a debt trap, adversely affecting credit health and financial stability,” Raza adds.