Offering lending institutions credit guarantees will help close the credit gap that Indian MSMEs are experiencing and promote the expansion of credit to the MSME sector.
In comparison to other growing countries, India has a very low percentage of its GDP allocated to credit provided to MSMEs. On the strength of high leverage, nations like China, South Korea, and even Bangladesh have experienced tremendous industrial expansion that has been mostly driven by MSMEs. More finance available to MSMEs encourages greater investment in productive assets, which stimulates economic growth and job creation.
Due to inadequate creditor and property rights, the informal economy, a lack of adequate accounting records, and information asymmetry, Indian MSMEs find it challenging to obtain financing. Also, due to their smaller loan quantities, lending to MSMEs has a considerably greater administrative cost. As a proportion of the underlying loan, greater resources are needed to gather data on MSME creditworthiness. As a result, lending to MSMEs may not always be considered economically sensible by lending institutions. All micro, small and medium enterprises should register their business on udyam registration portal to avail financial help from the bank.
Thus, collateral typically influences the loan decisions made by banks. Nevertheless, despite having a lot of potential and brilliant ideas, many first-generation MSMEs might not be able to meet the collateral criteria of banks. Hence, although having tremendous potential, many individuals and MSEs are unable to launch or expand their enterprises due to a lack of funding. Profitable initiatives of micro and small businesses may not be funded as a result of credit rationing, which would have a negative impact on the economy’s employment and investment levels.
It is vital to close the financial gap they are currently experiencing in order to transform today’s workers into tomorrow’s MSME and today’s microenterprises into tomorrow’s medium enterprises. According to the RBI, the MSME sector had credit outstanding of Rs 20.7 lakh crores as of September 30, 2022. The credit gap in the MSME sector in 2019 was pegged at up to Rs. 20–25 lakh crore, according to the report of the expert committee on MSMEs, which was presided over by a professional. This means that the rate at which credit is disbursed to the MSME sector must more than double.
In order to close this credit gap and promote the expansion of credit to the MSME sector, providing credit guarantees to lending institutions may become an increasingly significant factor. Credit guarantee institutions reduce the lender’s risk by offering guarantees to lending institutions and assuming a portion of the default risk. This is because guarantees ensure repayment of all or a portion of the loan in the event of default. Small enterprises now can avail small business from banks through detailed project reports.
Credit Assurance not only makes it possible for micro and small enterprises without collateral to get loans, but it also increases credit overall in the economy because many MSMEs would not have otherwise been able to get credit from lending institutions. Due to the fact that the issuance of guarantees lowers the capital adequacy ratio, credit guarantee also encourages lending institutions to cut capital provisioning.
When a component of a financial institution’s loan portfolio is guaranteed, the capital adequacy requirements for that piece of the portfolio are proportionally lower, which further enhances credit throughout the economy.
Additionally, lending institutions do not need to charge a higher interest rate to cover the risk associated with lending to SMEs because the full default risk is not assumed by lending institutions following the issue of credit guarantees. As a result, lending institutions can provide MSMEs loans at lower interest rates by offering credit guarantees in exchange for small guarantee costs.
It is significant to highlight that compared to directed credit or loan subsidies, subsidising credit guarantee institutions results in a 2x or 3x increase in credit disbursal. A public credit guarantee plan can guarantee a significant number of loans with a relatively modest capital basis and requires relatively little cash outlays, at least initially until credit losses manifest. Comparing risk management tools to equity or loan capital, empirical data indicates that they can maximise the utilisation of public money. Consequently, supporting institutions that provide credit guarantees may result in better and more efficient use of public funds. An increase in funding for the guarantee programme might result in a credit revolution for the MSME sector’s micro units, which would greatly increase employment.
Credit Guarantee Trust for MSMEs (CGTMSE) has become more crucial in India in allowing the growth of credit to the MSME sector by providing loan guarantees to lenders and so fostering confidence and risk aversion among the lenders. With a guarantee coverage ranging from 50% to 85% for different types of loans, CGTMSE offers credit guarantees for loans up to a maximum of Rs. 200 lakhs. The year-by-year guarantee cover offered by CGTMSE has been steadily rising since FY18 (Rs 19,066 crore), reaching Rs 45,851 crore in FY20 and Rs 56,172 crore in FY22, according to the most recent data.
A further infusion of Rs. 9,000 crores has been announced for the CGTMSE corpus in the Budget 2023–24, reflecting the importance of guarantee institutions in enhancing MSMEs’ access to credit. The Hon. FM stated in the legislature that this increased funding for the CGTMSE plan will allow for an additional Rs. 2 lakh crore in collateral-free guaranteed credit and lower the cost of the credit by roughly 1%.
To further increase the effectiveness of the CGTMSE scheme, more adjustments can be made. The number of member lending institutions who have signed up for the Guarantee cover is still quite low. Several banks consider the guarantee cost that the CGTMSE charges member lending institutions to be excessive. Hence, rationalising the charge for requesting guarantee coverage will significantly increase the amount of MSE loans covered by the guarantee programme. The most recent SBI study further recommends making CGTMSE coverage mandatory for all SME loans up to Rs 2 crore and lowering yearly guarantee fees to 0.50% of the loan amount across all slabs.
The research also recommends raising the cap on non-collateralized loans under the CGTMSE for micro and small units engaged in all manufacturing, service, and commerce sector activities from the existing INR 10 lakh to INR 20 lakh.
Moreover, lending institutions can disburse credit numerous times with the same outlay by pushing State Financial Corporation (SFC) to offer first and/or second loss guarantees to them rather than directly financing MSMEs off of their balance sheet. The SFCs currently offer financial support to MSMEs in a variety of ways, including direct term loans, direct subscription to stock or debentures, and seed capital, in addition to providing guarantees.
Sincere efforts must be made to raise the percentage of SFC guarantees given to lending institutions relative to their overall spending. However, establishing a state-level credit guarantee trust for MSMEs along the lines of the CGTMSE, which is at the national level, can also satisfy state-specific criteria and give MSMEs simple access to funding as well as banks with greater confidence.
The credit guarantees can play a significant role in helping Micro, Small, and Medium Enterprises (MSMEs) close the loan gap in India. The loan gap is the difference between the demand for credit by MSMEs and the supply of credit from formal financial institutions.
By providing credit guarantees, financial institutions can mitigate the risk associated with lending to MSMEs, making it easier for them to access credit. This can help MSMEs invest in their business operations, expand their operations, and create new job opportunities.
Credit guarantees can also help reduce the cost of credit for MSMEs, making it more affordable for them to borrow money. This can lead to an increase in the overall credit flow to the MSME sector, which is crucial for their growth and development.
It is, therefore, essential for the Indian government to promote and support the use of credit guarantees for MSMEs. The government can introduce policies and programs that encourage financial institutions to provide credit guarantees to MSMEs, thereby boosting their access to credit and helping them close the loan gap.
In conclusion, credit guarantees are a crucial tool for promoting the growth and development of MSMEs in India, and the government must take the necessary steps to ensure their effective implementation.