Copyright infringement not intended

Picture Courtesy: NDTV

Context:

 The Reserve Bank of India has directed banks not to insist on collateral security for loans up to ₹20 lakh for Micro and Small Enterprises (MSEs). The new provision will be applicable to loans sanctioned or renewed on or after April 1, 2026.

Key Provisions to reduce collateral barriers for MSEs:

• Enhanced collateral-free loan limit: The Reserve Bank of India has increased the limit for collateral-free loans to Micro and Small Enterprises (MSEs) from ₹10 lakh to ₹20 lakh, with the objective of improving access to formal credit for businesses that lack adequate assets to pledge as security.
• Mandatory coverage for PMEGP units: Banks have been directed to provide collateral-free loans up to ₹20 lakh to all eligible units financed under the Prime Minister Employment Generation Programme, which is implemented by the Khadi and Village Industries Commission to promote self-employment and rural entrepreneurship.
• Provision for higher limit based on performance: Banks may, based on the good repayment track record and sound financial position of an MSE unit, extend collateral-free lending up to ₹25 lakh in accordance with their internal risk assessment and credit policies.
• Availability of credit guarantee cover: To reduce the lending risk, banks are permitted to avail protection under the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), wherever applicable, thereby encouraging greater flow of unsecured credit to the sector.
• Clarification on voluntary collateral: The RBI has clarified that if borrowers voluntarily pledge gold or silver for loans within the collateral-free limit, such acceptance by banks will not be treated as a violation of the collateral-free lending mandate.

Significance of the RBI’s enhanced collateral-free loan limit for MSEs:

• Bridging the MSME credit gap: India has over 6.3 crore MSMEs, which contribute nearly 30% to GDP, 45% to exports, and employ around 11–12 crore people. However, as per estimates by the International Finance Corporation, the sector faces a credit gap of over ₹20–25 lakh crore, largely due to the lack of collateral. By raising the collateral-free loan limit to ₹20 lakh, the Reserve Bank of India directly addresses one of the biggest structural barriers to formal credit access.
• Promoting entrepreneurship and employment generation: Easy access to unsecured loans can significantly boost self-employment and micro-enterprise creation, especially in rural and semi-urban areas. For instance, enterprises supported under the Prime Minister Employment Generation Programme have generated over 80 lakh employment opportunities since its inception, demonstrating how small-ticket credit can translate into large-scale job creation.
• Strengthening financial inclusion and formalisation: Only about 16 - 18% of MSMEs currently have access to formal institutional credit, while the rest depend on informal lenders charging high interest rates. Collateral-free lending encourages small businesses to open bank accounts, maintain digital transactions (GST/UPI), and build credit histories, thereby integrating them into the formal financial system.
• Supporting economic resilience post-crisis: During the COVID-19 period, the Emergency Credit Line Guarantee Scheme (ECLGS) provided guaranteed collateral-free loans worth over ₹3.6 lakh crore, helping lakhs of MSMEs survive liquidity shocks. The success of this model demonstrated that credit guarantee-backed unsecured lending can sustain businesses and protect jobs, influencing current policy thinking.
• Risk balancing through credit guarantees: Banks can mitigate lending risks through the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), which provides guarantee cover for collateral-free loans. Since its launch, CGTMSE has approved guarantees for over 80 lakh accounts, enabling banks to expand unsecured lending without significantly increasing NPAs.

Concerns associated with enhanced collateral-free loans for MSEs:

• Rising credit risk and potential NPAs: Collateral-free lending increases the credit exposure of banks, as the absence of asset backing raises the risk of default. The MSME sector has historically shown higher stress levels, with MSME gross NPAs in the banking system hovering around 6 - 8% in recent years, raising concerns about asset quality if credit appraisal is weak.
• Possibility of credit misallocation: Without collateral discipline, there is a risk that loans may be extended to financially weak or non-viable enterprises, especially under pressure to meet lending targets. This could lead to evergreening of loans or diversion of funds for non-business purposes.
• Moral hazard and repayment discipline issues: Borrowers may exhibit lower repayment discipline when loans are unsecured and backed by guarantee schemes such as the Credit Guarantee Fund Trust for Micro and Small Enterprises, creating a moral hazard for both lenders and borrowers.
• Increased burden on credit guarantee mechanisms: A higher volume of unsecured lending may lead to greater claims under CGTMSE, potentially straining the financial sustainability of the guarantee framework and increasing contingent liabilities.
• Information asymmetry and weak financial records: Many micro enterprises lack formal financial statements, credit history, or GST records, making accurate risk assessment difficult and increasing the chances of adverse selection.

NITI Aayog recommendations for MSME:

• Unified digital ecosystem for MSMEs: A centralised, AI-driven single-window digital platform should be developed to integrate information on government schemes, regulatory compliance, credit access, and market opportunities. The portal can provide real-time support through interactive dashboards, automated compliance tools, AI-based assistance, and mobile accessibility, enabling MSMEs to navigate the ecosystem more efficiently.
• Data Integration for policy co- ordination: Convergence should be achieved at two levels. Information convergence involves pooling data generated by central and state governments to enable better coordination, monitoring, and evidence-based policymaking. Process convergence focuses on streamlining implementation by aligning similar schemes, consolidating overlapping components, and strengthening inter-ministerial coordination to reduce duplication and administrative complexity.
• Integrated approach to cluster development: Existing cluster initiatives need to be harmonised by aligning traditional industry programmes such as Scheme of Fund for Regeneration of Traditional Industries (SFURTI) with the Micro and Small Enterprises Cluster Development Programme (MSE-CDP). A dedicated sub-component for traditional sectors within a unified framework would improve governance, optimise resource utilisation, and simultaneously support heritage-based livelihoods.
• Rationalisation of skill development architecture: Skill development initiatives should be reorganised into a three-tier structure covering entrepreneurial and managerial capabilities, MSME-specific technical competencies, and targeted training for rural workers, artisans, and women. Consolidating overlapping programmes while retaining focused interventions would improve efficiency and inclusivity.

Conclusion:

The enhancement of collateral-free loan limits by the Reserve Bank of India is a significant step toward improving credit access, promoting entrepreneurship, and deepening financial inclusion for Micro and Small Enterprises. However, its long-term success will depend on robust credit appraisal, effective risk-sharing through guarantee mechanisms, and responsible lending practices to balance inclusion with financial stability.

Source: The Hindu