Banking / Finance · August 10, 2022

How Do Banks Make Money On Zero Interest Loan

Introduction

Many a times we have seen e-commerce websites provide lucrative facilities, one of which is no cost EMI. These loans and EMI are provided by banking and financial institutes. It is a noteworthy question to ask – How do the banks make money if they lend funds interest free?

Also Read: How Does Asset Management Company (AMC) Make Money

What is a Zero Interest Loan

A zero-interest loan, as the name implies, requires only the principal balance to be repaid, provided that the borrower meets the strict deadline by which the total debt must be met.

Failure to meet the deadline will result in severe fines. The lender may, revoke the zero-percentage clause and charge backdated interest to the loan.

Understanding how banks make money on loans

The banks that provide loans for individuals often make money by charging interest on the lender amount. Out of all the money collected from the borrower, some money is transferred to the depositors of the bank.

The difference between the interest charged to the borrower and passed to the depositor is the gains made by the banks.

Consider for example, a depositor has made a Fixed Deposit of Rs. 5 lakh. For the benefit of the depositor, the bank has promised to pay 5% interest per annum on the said amount. The role of the bank is now to pass on the money to those in need. If an individual borrows this money from the bank, it will charge 12% interest on the borrower. Thus, the net earning by the bank will be 7%.

It is to be noted that the bank is obliged to pay interest to the depositor even in the case when there are no borrowers for the bank. Also, the security and recovery of the amount is in the risk of the banks.

Banks making money on zero interest loans

At times, banks have a surplus amount of cash in their account which they desire to give away in the form of loans. Due to the lack of borrowers in the market, these banks turn towards the e-commerce websites to lend their money.

The banks collaborate with the specific products available in the line of array on the e-commerce store.

In this case, the interest rate is bared by the company. The banks make the gains from the desired interest charges, as the company pays the interest on behalf of the end user. Thus, enabling the consumer avail the goods at the same price.

It may appear to be zero interest to the consumer, but the banks make the gains from the company. This is a win win situation for both, the banks and the manufacturer. The banks lend more money and gain interest and the company makes more sales.

Things to keep in mind

It is to be noted that interest free loans and EMI usually look lucrative from the outside, but they usually compel the consumer in buying commodities out of their expense needs.

Many a times, the banks that provide interest free loans / EMI, charge a nominal fee called “processing fee”. One needs to also factor in the desired cost before settling for the product.

For example, a processing fee of Rs. 150/- on a product of Rs. 3000/- usually translates as a interest of 5% on the principle amount.

The duration of these loans / EMI do not last for more than 6 months. Thus, one needs to make a wise decision before opting for an interest free loan or choosing an EMI option.

The consumer needs to also be aware of the hefty penalties charges in the case when he delays any payment of installments.

Conclusion

It is to be noted that, the facilities like interest free loans are add on benefits to attract the consumer in buying the product. Thus, creating an ease to buy expensive products.

The goods / products that are available on interest free EMI usually get sold off at a discount rate in the time of sale. Thus, one needs to check the price difference during the peak sale periods.

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