MSME Credit

Micro, Small, and Medium Enterprises (MSMEs) are a vital segment of the economy, and banks have a special focus on lending to MSMEs.

Definition and Classification of MSMEs

The definition of MSMEs in India was revised in 2020 to incorporate both investment and annual turnover criteria (under the MSME Development Act, 2006). As of the latest classification:

• A Micro Enterprise is one with investment in plant and machinery or equipment not exceeding ₹1 crore and annual turnover not exceeding ₹5 crore.
• A Small Enterprise has investment up to ₹10 crore and turnover up to ₹50 crore.
• A Medium Enterprise has investment up to ₹50 crore and turnover up to ₹250 crore.

Both conditions (investment and turnover) are considered – exceeding either threshold moves the enterprise to a higher category. For example, a manufacturing unit with ₹8 crore investment and ₹40 crore turnover is “Small”. If it grows to ₹12 crore investment and ₹60 crore turnover, it becomes “Medium.” This updated composite definition has allowed more firms to qualify as MSMEs and avail benefits, without fear that growing turnover will immediately disqualify them (since investment limits are also to be breached).

Importance of MSMEs: They contribute significantly to GDP, exports and employment. However, MSMEs often face challenges in accessing formal credit due to lack of collateral or formal financial records. Recognizing this, the government and RBI mandate Priority Sector Lending for MSMEs (banks must allocate a portion of credit to this sector), and have introduced schemes to support MSME financing.

Credit Support Schemes for MSMEs

Several schemes aim to ease credit flow to MSMEs by reducing collateral requirements or providing guarantees/subsidies:

CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises)

This is a flagship scheme launched by the Government of India (Ministry of MSME) and SIDBI. The CGTMSE provides a guarantee to banks for loans given to micro and small enterprises without collateral. Essentially, if an MSE borrower defaults, CGTMSE will cover a major portion of the loss to the lender (up to a certain limit). As of April 1, 2023, the guarantee cover limit under CGTMSE was increased to ₹5 crore from the previous ₹2 crore.

This means banks can give collateral-free loans up to ₹5 crore to eligible MSEs and still be largely protected by the guarantee. Typically, the guarantee covers 75-85% of the loan amount (85% for smaller loans, and special categories like women entrepreneurs get higher coverage). Banks pay a guarantee fee and annual service fee to CGTMSE for this cover.

The effect of CGTMSE is that lack of collateral is no longer a barrier for MSME loans – even if a small entrepreneur has no property to pledge, the bank can rely on the CGTMSE guarantee and lend. This promotes financial inclusion of viable small businesses. Since inception, lakhs of guarantees have been issued, enabling many crores of credit to the sector. For borrowers, the scheme might mean slightly higher interest (to cover guarantee fees), but it opens doors to formal credit. From the bank’s perspective, the risk is mitigated by a sovereign-backed guarantee fund.

Emergency Credit Line Guarantee Scheme (ECLGS)

This scheme was introduced as part of the COVID-19 relief package (Atmanirbhar Bharat) in May 2020. Under ECLGS, government guarantees 100% of additional working capital loans given by banks to existing MSME and other business borrowers impacted by the pandemic.

Initially targeted at MSMEs, it was extended to other sectors like hospitality later.

Key features

Businesses with outstanding loans below a threshold (e.g. ₹50 crore initially, later higher for different versions) could get up to 20% of their outstanding credit as an emergency credit line – this was a soft loan with capped interest (e.g. 7.5%) and initially a moratorium period. Because these loans were fully guaranteed by NCGTC (a government trust), banks readily disbursed them. The scheme proved crucial to help small businesses survive liquidity crunch during lockdowns.

Scope and extension

ECLGS was expanded multiple times – the total guarantee amount was increased from ₹3 lakh crore to ₹5 lakh crore, and the validity extended to cover loans sanctioned up to March 31, 2023. Different ECLGS versions (1.0, 2.0, 3.0, 4.0) catered to various segments (like 2.0 for larger firms in stressed sectors, 3.0 for hospitality etc.). By Aug 2022, about ₹3.67 lakh crore of loans were sanctioned under ECLGS.

Relevance

From exam perspective, remember ECLGS as the 100% government-guaranteed emergency credit program during COVID-19, totaling ₹5 lakh crore cover, enabling banks to lend to struggling MSMEs without fear of default loss. This kept credit flowing in tough times and is estimated to have saved many MSMEs from collapse. The scheme is implemented through NCGTC (National Credit Guarantee Trustee Co.) which also handles CGTMSE.

Other Support and Schemes

Priority Sector Lending (PSL)

All domestic banks must ensure 7.5% of Adjusted Net Bank Credit goes to Micro enterprises (a sub-target under PSL), and overall a significant portion to MSMEs. This regulatory push means MSMEs have a mandated share in bank lending – non-achievement can lead to penalties or depositing shortfall in funds like SIDBI’s.

Interest Subvention

The government had a 2% interest subvention scheme for MSMEs (interest relief on fresh or incremental loans) in the past to reduce borrowing cost.

MUDRA Loans (PMMY)

The Pradhan Mantri Mudra Yojana provides collateral-free micro loans up to ₹10 lakh, mainly through NBFC-MFIs and banks, for small businesses and non-corporate micro enterprises. Loans are categorized into Shishu (up to ₹50k), Kishore (₹50k to ₹5 lakh), Tarun (₹5–10 lakh). These are refinanced by MUDRA Ltd and guaranteed by a Credit Guarantee Fund for Micro Units. MUDRA has significantly boosted tiny enterprise lending (over ₹24 lakh crore disbursed in aggregate since 2015).

Stand-Up India

This scheme mandates each bank branch to lend to at least one SC/ST and one woman entrepreneur (in the ₹10 lakh to ₹1 crore range) for greenfield enterprises. It also has a guarantee scheme (CGFSI) to cover these loans. It’s aimed at promoting entrepreneurship among underrepresented communities.

SIDBI & Refinancing

SIDBI (Small Industries Development Bank of India) provides refinancing to banks for MSME loans and runs direct schemes (like SMILE) for MSME funding. There are also initiatives like SRI Fund (Self-Reliant India Fund) – a ₹50,000 crore equity fund-of-funds to help MSMEs with growth capital.

All these measures create an ecosystem where MSMEs – despite often lacking collateral or having higher risk – can access credit and support. From the bank’s viewpoint, guarantees and refinancing reduce the risk and cost of lending to MSMEs. From the economy’s view, supporting MSME credit is crucial for job creation and inclusive growth.