Credit Guarantees in India: Trends and Concerns

Context: The Union government has launched various Credit Guarantees schemes to strengthen the credit delivery system and facilitate the flow of credit to bolster economic activity. However, the sustainability and long-term implications of government-backed guarantees need careful evaluation. 

Loan Guarantee schemes in India

• Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE): Supports MSMEs by providing collateral-free loans. Revamped Credit Guarantee Scheme for Micro & Small Enterprises Scheme (CGTMSE Scheme) 

• Emergency Credit Line Guarantee Scheme (ECLGS):
  • Introduced in 2020 to provide additional working capital support to businesses (focus on MSMEs, hospitality, tourism, healthcare) affected by the COVID-19 pandemic. 
  • It provides Member Lending Institutions (MLIs), 100% guarantee against any losses suffered by them due to non-repayment of the ECLGS funding by borrowers.
• Mutual Credit Guarantee Scheme for MSMEs (2025): 
  • In pursuance of the Union Budget 2024-25 announcement, the Mutual Credit Guarantee Scheme for MSMEs (MCGS - MSME) has been launched recently. 
  • MCGS- MSME scheme will provide 60% guarantee coverage by National Credit Guarantee Trustee Company Limited (NCGTC) for facilitating loans up to Rs. 100 crore to MSMEs for purchase of machinery or equipment without collateral.
  • Mutual Credit Guarantee Scheme for MSMEs 
• Enhanced Credit Availability in Union Budget 2025-26: 
  • Credit guarantee cover for micro and small enterprises (MSEs) is increased from ₹5 crore to ₹10 crore.
  • Credit guarantee cover of startups will double from ₹10 crore to ₹20 crore, with a reduced fee of 1% for loans in 27 priority sectors.
  • Exporter MSMEs will benefit from term loans up to ₹20 crore with enhanced guarantee cover. 
• Stand-Up India Scheme:
  • It facilitates bank loans between Rs 10 lakh and Rs 1 Crore to at least one Scheduled Caste (SC) or Scheduled Tribe (ST) borrower and at least one woman borrower per bank branch for setting up a greenfield enterprise. This enterprise may be in manufacturing, services or the trading sector. 
• Startup India Seed Fund Scheme (SISFS): Launched in 2021 to offer financial support to innovative startups.
• Pradhan Mantri Mudra Yojana (PMMY): Facilitates micro-financing by offering loans to small businesses.
  • MUDRA Loans hit All Time High 
• Atmanirbhar Bharat Abhiyan Credit Guarantee Scheme (2020): Aimed at revitalising MSMEs and facilitating the recovery of the economy post-pandemic. 
• Kisan Credit Card (KCC): Provides timely credit support to farmers to support their cultivation needs. As of March 2024, India has 7.75 crore operational KCC accounts with a loan outstanding of ₹9.81 lakh crore. 

Positive impacts of government loan guarantees

• Enhance liquidity and solvency:
  • Government guarantees have improved the liquidity of MSMEs, enabling them to sustain operations during periods of economic strain. 
  • E.g., Emergency Credit Line Guarantee Scheme (ECLGS) provided working capital support to businesses and prevented bankruptcies during COVID-19 pandemic.
• Reduction in Non-Performing Assets (NPAs):
  • Government-backed guarantees (assurance of guarantees) encouraged banks to offer credit more freely. It has contributed increased formal credit and reduction in NPAs in public sector banks, showcasing an improved repayment rate from businesses benefiting from these schemes. 
  • E.g., The gross NPAs in MSME loans by Scheduled Commercial Banks had declined by over 18% to Rs 1.25 lakh crore in FY24 from Rs 1.54 lakh crore in FY22. 

Concerns associated with loan guarantees

• Over-reliance on government guarantees:
  • Small borrowers often back comprehensive financial records, which makes risk assessment for the lenders complicated. 
  • Perpetual dependence on government-backed guarantees may discourage banks to conduct thorough credit appraisals, which could lead to potential moral hazard. 
  • This could lead to financial instability, if these guarantees are misused or extended too freely.
• Increased defaults and fiscal burden:
  • If the borrowers (especially MSMEs and startups) default on their loans, the government will bear the liability, which could strain public finances and lead to higher fiscal deficits.
• Impact on fiscal deficit and debt:
  • The Fiscal Responsibility and Budget Management Act has restricted the Central Government to extend guarantees up to 0.5% of GDP in any financial year, there is no concise definition around the informal form of implicit support by the government. 
  • The government has used loan guarantees as a substitute for direct public investment, especially in infrastructure, to curtail fiscal deficit. However, this approach could increase the fiscal deficit if large-scale defaults occur. 
  • Moreover, guarantees are often difficult to account for in the national budget due to their contingent nature, leading to challenges in financial reporting.

Way Forward for Loan Guarantees

• Transparency in financial reporting: 
  • The shift towards better accounting standards for MSMEs and startups is crucial to improving transparency and reducing risks associated with loan defaults. 
  • This includes disclosing the range of expected outcomes and their probabilities to help policymakers assess whether the risks associated with the guarantees are manageable.
• Merit-based support for startups:
  • Government guarantees should be directed towards startups based on merit-based assessments rather than blanket support. 
  • Factors such as corporate ethics, governance capacity, and leadership style should be considered before granting guarantees. 
  • This can ensure that these firms can sustain themselves without long-term dependence on government support.