Introduction

In the world of e-commerce, attractive facilities such as “no cost EMI” have become increasingly common. These loans and EMIs are made possible by banking and financial institutions. However, a significant question arises – How do banks manage to make money if they lend funds without charging any interest?

What is a Zero Interest Loan

A zero-interest loan, as the name suggests, requires only the principal balance to be repaid within a specific deadline. If the borrower fails to meet the deadline, they may incur severe fines, and the bank might revoke the zero-percentage clause, applying backdated interest to the loan.

Understanding how banks make money on loans

Banks that provide loans to individuals generate income by charging interest on the lent amount. When borrowers repay their loans, a portion of the money collected is transferred to the bank’s depositors. The difference between the interest charged to the borrower and the interest paid to the depositor represents the profit made by the banks.

Let’s consider an example: A depositor invests Rs. 5 lakh in a Fixed Deposit with a promised interest rate of 5% per annum. If an individual borrows this money from the bank, the bank may charge 12% interest on the borrower. Consequently, the net earnings for the bank would be 7%.

Even if there are no borrowers, the bank is still obligated to pay interest to the depositors. Additionally, the bank carries the risk of security and recovery of the amount lent.

Banks making money on zero interest loans

Sometimes, banks have excess cash in their accounts and seek opportunities to lend it out as loans. When there is a lack of borrowers in the market, these banks collaborate with e-commerce websites to lend their money. The banks partner with specific products available on the e-commerce platform.

In this scenario, the company bears the burden of the interest rate, allowing consumers to avail the goods at the same price without any apparent interest. However, the banks profit from the desired interest charges, as the company pays the interest on behalf of the end-users. This situation results in a win-win for both the banks and the manufacturers. The banks lend more money and gain interest, while the company generates more sales.

Things to keep in mind

While interest-free loans and EMI schemes may appear enticing, they often prompt consumers to purchase goods beyond their essential needs. In many cases, banks offering interest-free loans or EMIs charge a nominal “processing fee,” which essentially translates to a hidden interest on the principal amount.

Consumers should also consider the total cost of the product before opting for an interest-free loan or an EMI option. The duration of these loans or EMIs is typically limited to six months, so making an informed decision is crucial.

Furthermore, consumers must be aware of the hefty penalties charged in case of delayed payment of installments.

Conclusion

Facilities like interest-free loans serve as attractive add-on benefits to entice consumers to make purchases. They provide an easy way to buy expensive products without immediate financial strain.

However, consumers should keep in mind that products available on interest-free EMIs are often sold at a discount rate during peak sale periods. Therefore, it is essential to compare the prices before making a decision to ensure the best deal.

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