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Five questions on Government’s Rs 3 lakh crore MSME collateral-free loan scheme

One of the big announcements made by Union finance minister, Nirmala Sitharaman during her first press conference to explain the details of Rs20 lakh crore Covid-19 economic package was the Rs 3 lakh crore collateral-free loan scheme for  micro, small and medium enterprises (MSMEs).

Unsurprisingly, the announcement cheered small firms. According to this scheme, the government will offer full credit guarantee for the loan amount to banks in the event of these loans turning bad. The scheme is big considering that the MSME sector is struggling for funds in the wake of COVID-19 crisis.

This sector contributes over 28 percent of GDP and more than 40 percent of country's exports, while creating employment for about 11 crore people. In other words, MSMEs are one of the major employers in the Indian economy. But will this Rs 3 lakh crore loan scheme really help MSMEs? What will be the implications in the banking system?

There are five critical questions here:

1. Already risky segment

Banks already have very high exposure to this segment. According to Reserve Bank of India (RBI) data, as at end March, 2020, banks have a total loan outstanding of Rs 29 lakh crore to MSMEs. Around 9-10 percent of non-performing assets (NPAs) of banks are from this segment. Banks have significantly cut down their exposure to MSMEs due to high stress.

In fact, in the 12 months period ending March, 2020, banks haven’t really lent to this category. The year-on-year growth rate has remained nearly flat, at 0.7 percent. Rs 3 lakh crore additional exposure will be significant (around 10 percent of the current outstanding).

Even with collateral guarantee, banks are finding it extremely difficult to recover money from MSMEs because of sharp deterioration in the economic conditions. PSU banks, which are already struggling for capital, would be taking up significant additional stress by lending to these firms at a time when economy is on a downward course. Why would PSU banks, which are the mercy of government for survival capital, do that?

2. Fundamentally a demand problem

These are ultimately loans that needs to be paid back by small companies. Remember, these firms are already in bad financial condition. MSMEs are companies which are engaged in supply of goods or machinery parts to big companies.

Typically, they don’t have large cash flows or promoters with deep-pockets. In the current economic scenario (the economy was slowing even before Covid-19 onslaught in the economy), unless demand situation improves, MSMEs are unlikely to make enough revenue to pay back these loans to lenders.

So far, there has been no significant attempt on the part of the government to stimulate demand in the economy by directly putting cash in the hands of people. How will MSMEs pay back the debt in another few years if the business doesn’t pick up?

Even with government guarantee, banks will have to show the defaulted loans as NPAs (non-performing assets) on their books and accordingly make provisions (money set aside to cover problematic loans). The point is instead of forcing these companies borrow more loans, government should have given them cash stimulus to deal with present crisis.

“Unless you generate demand on the ground, how will companies generate cash flows to run their operations and repay banks,” asked an NBFC industry official.

3. Enforcing credit guarantee


The comfort for banks, in this case, is 100 percent government guarantee on these loans. But, again, enforcing this guarantees may not be as easy as it sounds. Although there have been certain credit guarantee schemes in the past, there is no precedent for government giving full guarantee for something like Rs 3 lakh crore loan scheme.

According to bankers, in the event of default, banks will have a tedious process to get their money. Also, the government will have to verify the cases and compensate banks which will take time.

The money may not come in time from a fiscally constrained government. “It is not going to be easy. There is no way banks are getting money that easy from the government if these loans turn bad,” said a former chairman of a state-run bank. Banks will be wary to give away these loans because of this reason.

4. High probability of misuse

Like any government scheme, PSU banks will be under pressure to meet the short targets set by the government to make the MSME loan scheme a success. This will increase the chances of bankers overlooking the creditworthiness of the borrower to meet the heavy targets.

There is also a possibility of bankers facing political pressure at local level to give loans to unworthy, politically connected borrowers. Actually, immediately after the announcement of the scheme, banks have already started getting calls from companies seeking availability of this scheme.

How will government ensure these loans are indeed reaching the needy and not smart promoters who want to cash in on the opportunity? “In a way, this scheme is likely to end up as loan mela. Bankers will be forced to push credit to meet the targets given by the government. The recovery of money, even with government guarantee, will not be easy. Certainly not healthy to banking system,” said another banker, who too spoke on condition of anonymity.

5. No solution to immediate cash woes

The cash requirement is urgent. Loan processing will take time. Many MSMEs, especially smaller ones, have already run out of money to pay staff salaries, rents and other expenses on account of an already slowing economy and prolonged lockdown.

These firms need funds to meet immediate payment obligations. Majority of these companies already have loans with different financial institutions.

Asking these entities to take more loans at a time when there is no improvement in their ground operations on account of low demand is no solution, but will only create a bunch of over-indebted companies and huge bad loans after 3-4 years.