What is a Soft Loan?

Credit: thebalance.com

Soft loans are loans with more generous repayment terms than most commercially available loans. They are also referred to as “concessional loans,” and they may have below-market interest rates and long grace periods before repayment starts. 

Soft loans are typically offered by governments, government agencies such as export-import banks, and developmental institutions to aid developing nations and address crises.

Definition and Examples of Soft Loans

Soft loans offer more generous repayment options than loans at the market rate. They are generally made by government agencies or developmental institutions.

  • Alternate name: Concessional loan

While lenders offer most loans with the goal of earning a profit, they offer soft loans for other reasons. Soft loans might be used to address disasters such as the growing refugee crisis and to strengthen or weaken allegiances between nations.

For example, in 2021, the Export-Import Bank of India agreed to provide a soft loan worth $10.4 million to Eswatini to construct a disaster recovery site.

The Export-Import Bank of Thailand also established a soft loan program for businesses impacted by the COVID-19 crisis. These loans carried a special interest rate of 2% annually for the first two years, and borrowers could repay the borrowed amount over seven years. No payments were due for the first six months.

How Do Soft Loans Work?

Soft loans have much more favorable repayment terms than traditional sources of financing. Common features include:

  • Long grace periods before borrowers must start making payments
  • Interest rates below market value

In many cases, borrowers must use their soft-loan money for a specific purpose, such as providing aid to refugees or investing in infrastructure, agriculture, or information technology.

Because soft loans are not traditional loans, there’s no application process as there would be for most borrowers of conventional loans. Agencies sometimes decide to make these loans to developing nations for a strategic purpose, such as strengthening political alliances, rather than based on the borrower’s credit profile or ability to repay the loan. 

Like most loans, soft loans typically have a repayment period and may even provide 0% financing. 

A good example of a soft-loan provider with 0% rates is the International Monetary Fund (IMF), which offers soft loans via three different lending programs: extended-credit (ECF), standby-credit (SCF), and rapid-credit (RCF) facilities: 

  • ECF: 0% for a limited time, no payments due for the first five-and-a-half years.
  • SCF: 0% interest for a limited time, no payments due for the first four years.
  • RCF: Permanent 0% interest rate, no payments due for the first five-and-a-half years.

Who Offers Soft Loans?

Government agencies and developmental agencies typically issue soft loans. Export-import banks and groups such as the IMF are examples of organizations or federal agencies that offer soft loans. The terms of the loans are set by these agencies and negotiated with the recipients.

In 2019 the Saudi Fund for Development (SFD) issued a pair of soft-loan agreements for $140 million to Ethiopia that was negotiated by the two groups.

Do Soft Loans Offer a Return?

While soft loans can provide opportunities for economic growth for recipients, lenders who make soft loans may not see positive returns on their financing for years, if ever. And, in some cases, borrowers can become overwhelmed with payment obligations, which can worsen their economic situation rather than improve it.