The Truth behind No-Cost EMIs

When you purchase a product, you have two options for how you want to pay. Either you can pay the total amount upfront or you can pay in installments. We all love paying in installments, be it our loans and if given an option, even on our phones we buy from Amazon or Flipkart.

The process of paying in instalments is known to us as Equated Monthly Installments or EMI. This EMI will sometimes even carry some interest charges. But still many people find it interesting. This is because many of us don't want to pay at one time. Sometimes we don't have enough money or even we have, we want to allocate it to different things. 

And in the last few years, when we buy products online we see an option of Zero-Cost EMI or No-cost EMI. 

That means you don't have to pay any interest even if you pay in instalments. If the product is worth Rs 30,000, you have to pay this amount only in 3,6 or even 9 months without any interest! But hey! Why are companies or retailers so generous? Do they really care so much about the customers that they are ready to cause trouble to their own books? We don't think so. Why? Checkout below.

RBI's notice on No-cost EMI (2013)

In 2013, The Reserve Bank of India (RBI) released a statement on the prevailing and rising use of the concept of zero percent interest. RBI clearly stated that no-cost EMI or zero cost EMI does not exist. Money always comes with a cost associated with it. 

In the zero percent EMI schemes offered on credit card outstandings, the interest element is often hidden and passed on to the customer in the form of processing fee. Since the very concept of zero percent interest is non-existent and fair practice demands that the processing charge be kept away, it is cheating the customer. 

This statement disregards the practice of zero-cost EMIs. It can only be offered to those people who offer absolutely no risk. But in the real world, every borrower or customer possesses a risk of default. 

The Normal Scenario

You will think that you are not paying any interest rate, but in reality, you are paying a hefty interest rate. Suppose that the retailer has to pay Rs 16,000 to the manufacturer of the handset. The extra Rs 4,000 it gets from the customers like you and me will be the retailer's profits. The MRP of the smartphone is Rs 20,000 and the manufacturer requires Rs 16,000 from the retailer. From Rs 16,000-Rs 20,000, the retailer can sell the product at any cost. 

To increase their revenue, they can either increase the price of the smartphone or can sell a higher number of products. They cannot afford to sell at a higher price because the MRP is Rs 20,000. The only way to increase revenue is to generate higher sales. How can that be done? "No-Cost EMIs!"

Decoding No-Cost EMIs

Suppose you want to purchase a smartphone worth Rs 20,000 online. The first option is to pay Rs 20,000 at one go and get your handset. The second option is to buy the device at no-cost EMI of Rs 1,667 for next 12 months. This means that you have to pay Rs 1,667 every month for the next year. This adds up to Rs 20,004 (Rs 1,667 x 12). Obviously, the second option makes more sense. You don't have to pay anything more and at the same time, you are saved from spending a large amount at one time. 

This is where banks enter into the frame. They tell retailers to offer their customers the option of no-cost EMIs. In return, banks will take half of the profit (as per the above example: Rs 2,000). If the retailers were able to sell 100 smartphones at the upfront cost of Rs 20,000, the no-cost EMI scheme will help them to drive the demand up. Now they will be selling 250 smartphones at the same Rs 20,000, thus, generating a revenue of Rs 50,00,000. Banks take Rs 5,00,000 as their share and retailers will have a profit of Rs 5,00,000.

Conclusion

As a customer, you are benefitting because you don't have to pay the money upfront. The retailer is benefitting from higher revenue and profits due to increased sales. The banks are benefitting as they are getting their share. The smartphone manufacturer company is already receiving the amount they wanted for their handset. So, in all, no-cost EMIs are helping everyone. Then, what is the bad part about it?

The economy has to bear the brunt of this higher demand. This artificial increase in demand lures customers to buy products at the no-cost EMIs. As they have to pay less upfront, they buy more products. The retailers have the option to sell the device at a lower price but because they have to pay a share of their profit to the banks, they charge you more. 

In our example, the retailers could have sold the product at Rs 18,000 and still had Rs 2,000 profit. But to increase their sales, they take Rs 2,000 from your pockets and give it to the banks. So, indirectly, you are already paying 10% of the interest rate to the bank as per the example. 

In the short term, yes it is indeed beneficial for us! So we benefit from being able to buy expensive products in installments without any interest. Banks make profits by taking money from the seller. And sellers make more money because sales will increase!

But in the long term, prices of products will go up, and inflation will occur. Definitely not something good for the consumer, or for the economy. Let us just enjoy it while the fun lasts.