Why Many Small Businesses in India Are Turned Down for Business Loans?
If you are planning to apply for a business loan in India, you need to go through a detailed process through which lenders approve or reject a loan application. Getting a loan at the right moment can help you boost your business significantly. Hence, you need to learn the reasons that affect your chances of getting a business loan.
The following are some of the main reasons why some lenders may reject your application for a business loan.
5 Reasons Why Lenders Turn Down Small Business Loans
A lending company, or a bank can turn down a business loan for several reasons. However, in most cases, the 5 factors mentioned below are the main reasons for lenders to turn down a small business loan.
- Poor Credit History
One of the most crucial factors while applying for a loan is the credit history of the business and the business owner. If the business owner has poor or no record of credit then the chances of rejection are significantly high. Businesses that delay repayment of prior credit or have a constantly poor credit record are rejected when applied for a business loan.
Some financial institutions also reject loan applications for businesses that are new and have no active credit record. They may have requirements of a minimum business vintage for approving loans.
- Incomplete Documentation
Another major reason to reject a business loan is incomplete or wrong document submission. Some businesses often lack the complete documentation that is necessary to apply for a loan. Your loan may also get rejected if you do not understand the documentation requirements to apply for a loan.
Lenders require KYC documents as well as proof of income, business licences, etc. When applying for a business loan, you should check all the documentation requirements on the lender’s website to avoid complications during the application process.
- Nature of the Business
The process of lending money to a business is a highly regulated one. Hence, lenders are required to scrutinise all factors that may or may not affect the repayment capability of the business.
One of the important factors is the nature of a business. Lenders will analyse the risk factors affecting the business, its product or service type, stakeholders, etc., to determine the risk of lending money. Therefore if a business has a high-risk factor or any other negative determinants then it may result in the rejection of a small business loan.
- Lack of Collateral
Banks and other lenders are more willing to make loans with availability of collateral.. If you try to get a loan without collateral then the chances of rejection are usually higher. Lack of collateral indicates a higher risk of recovery after default and hence it is a major reason for loan rejections.
Applications for loans with longer tenures or higher value are more likely to be rejected without collateral. The nature of the collateral being submitted also affects loan approval.
- Lack of Financial Planning
Lending entities always look for the main reason you are applying for a loan. The financial plan of your business is an important factor to determine whether you can repay the loan or not.
Usually, if a business is applying for a loan to manage existing credit or other risk factors like that, then the chances for rejection are higher. Remember to have a sound business plan when asking for a small business loan.
How to Avoid Rejection While Applying for a Business Loan?
Despite several risks and challenges, most businesses fund their day-to-day operations through loans. As a commercial organisation, you need to fulfil the basic criteria of a lending institution and maintain healthy business practices to increase your chances of availing of a business loan.
You can simply focus on the factors listed below to increase your chances to get a small business loan.
- Apply With Valid Reasons
While applying for a loan, you should ensure that you provide a valid reason for your application. You might want to use the loan amount to get more raw materials or develop a production unit; having a proper financial plan will make it easier to get the loan.
- Good Credit Record
Credit scores provided by credit bureaus taking into account all credit activities of a venture. To improve your business’s credit score, you need to clear outstanding debts in time. A healthy credit score will ensure a good credit image for a business and improve the chances of getting a loan at better terms.
- Know Your Lender
Before you apply for a loan, do your research and find a lender who is providing better terms. Check all required eligibility criteria and ensure that you can fulfil them. Check their scrutiny process and loan rejection rate and other details. It will help you to satisfy the requirements of a lender and decrease the chances of rejection.
- Right Timing
If you apply too early after starting a business, you will not have enough financial data to prove your creditworthiness. Hence, you should build a financially strong business and then apply for a loan.
- Arrange for Collateral
Providing sufficient collateral is one of the assured ways to get a loan. As mentioned above, lenders hesitate to approve a loan if it’s a new business. However, if you provide collateral you can get a loan without worrying about the right timing or several other parameters.
A lending institution like a bank or an NBFC (non-banking financial company) will have stringent parameters that borrowers must fulfil to get a small business loan. Not knowing or being able to fulfil these parameters will lead to the rejection of your loan application.
As a business, you may require a loan to manage critical business concerns, and so you cannot afford to be rejected. Therefore you should be careful about the parameters mentioned above while applying for a small business loan in India.
Frequently Asked Questions
What are the disadvantages of a loan for a small-scale business?
Small-scale businesses find it difficult to take and manage loans for several reasons. Typically lenders are more hesitant to lend money to small businesses. Hence, the interest rates, tenure, etc., are usually not in the borrower’s favour.
What is the credit score of a borrower?
Credit score in India refers to a 3-digit number ranging between 300 and 900 that reflects the creditworthiness of the borrower.
What is the meaning of collateral in loans?
A collateral is an item of value that is provided to lenders as a guarantee against the loan taken from the lender. In case you default on your loan repayment, the lender has the authority to seize the asset and recover all outstanding dues by liquidating the collateral. So, the collateral requirements are usually of equal or higher value than the loan amount.
Is a business loan taxable in India?
Loans are not part of your income as per your business accounts. Hence, a business loan is not taxable for you as a borrower. However, you need to pay interest for taking business loans.