Sunday, February 5, 2012

Credit Guarantee can help improve funding access for SMEs

Credit Guarantee can help improve funding access for SMEs

The prelude to the Budget session of the Parliament elicits expectations from various interest groups every year. Here is one such expectation from the Small and Medium Enterprises – improved access to capital at reasonable cost by enabling liberal credit guarantee schemes for the sector.  The current scheme, christened Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), founded in 2000 has made some progress in its 12 years of existence. However given size and scale of SME sector in India, a much broader credit guarantee scheme with higher credit limits should be enabled by the Government of India to address the needs of the sector. This initiative, coupled with defined mandates for banks to implement the scheme could dramatically improve access to finance for SMEs that account for almost half of India’s industrial output and exports. 

SMEs in India have traditionally been hamstrung by poor access to capital to fund their growth needs.  As per RBI data for 2010, 94% of non-consumer banking accounts enjoy less than 30% of the non-consumer bank credit facilities, which clearly highlights the dearth of access to banking facilities for SMEs.  While the Government has clearly identified this as an area of concern several years back, very few initiatives have been taken to address this lacuna.

International experience

Credit guarantee schemes, with certain minimal risk sharing by the lender and significant credit loss absorption by the Guarantor, will significantly improve access to credit facilities for SMEs, as has been witnessed in several other countries. Japan and Korea, both with vibrant SME sectors, have outstanding SME credit guarantee in excess of 5% of their GDP, as compared to approx. Rs. 10,000 crores accounting for less than 0.2% of GDP in India.  China had identified the same concern in late 1990’s and encouraged state-sponsored credit guarantee institutions by regional and provincial governments; today China has over 4000 credit guarantee institutions, with over RMB 1 trillion outstanding credit guarantee, or about 3% of its GDP.

India has a long way to go

Credit guarantee in India started in 2000 with a well-defined scheme – central government guarantee against default for loans to SMEs that are extended without any collateral, upto 75% of the credit loss to the lending bank.  Even new enterprises without any track record can avail this facility, if the proposal meets the credit requirements of the lending bank.  However, 12 years later, most banks have not popularized this product and are still reluctant to freely extend collateral-free loans to SMEs.  Also, the cap on the amount, recently enhanced from Rs. 50 lakhs to Rs. 100 lakhs is still measly in the current context and need significant upward revision to, say, Rs. 5 crores.

Ways to improve reach of credit guarantee schemes

India can replicate the Chinese model and encourage multiple credit guarantee institutions, licensed by the insurance regulator. Once the government-supported institutions prove the business model, private sector participation in creating credit guarantee institutions – by banks, insurance companies, etc. - can be encouraged.  Simultaneously, the banking regulator should actively encourage banks to give thrust to this product, in ways similar to the incentives provided to the housing finance by banks.
Despite the current fiscal scenario faced by the Central Government, credit guarantee schemes can be easily supported by the Government as corpus fund contribution by Government can support credit to the tune of over 50 to 100 times the contribution as funds may be needed only to meet the credit losses of 1-2% over and above the guarantee fees collected.

N. Muthuraman is Director, RiverBridge Investment Advisors Pvt. Ltd., a boutique financial advisory firm and can be reached at 

This is the blog of the Print Version published in Business Line dated 6th Feb 2012

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