Credit Guarantee- A reality check
In the post- COVID scenario, MSME financing is almost identified with Credit Guarantee schemes. We look at its effectiveness and appetite among the consumers (MLIs).
Credit guarantee was born with a promise to ensure the availability of bank credit without the hassles of collaterals / third party guarantees to the entrepreneurs and others, Initially, it was established for Micro and small enterprises since the year 2000 as CGTSME (Credit Guarantee Scheme for Micro & Small Enterprises). In 2014-15, the credit guarantee got a huge boost with establishing National Credit Guarantee Trust Company(NCGTC) and the scope of credit guarantee expanded to include educational loan, MUDRA loan, Skill Development Loans, and Standup India Loans. The scheme operates with a pre-condition that these loans are not covered with any collateral security/personal guarantee by the MLI(Member Lending Institutions)
The main objective is that the lender should give importance to project viability and secure the credit facility purely on the primary security of the assets financed. The other objective is that the lender availing guarantee facility should endeavour to give composite credit to the borrowers so that the borrowers obtain both term loan and working capital facilities from a single agency.
The Credit Guarantee Scheme (CGS) seeks to reassure the lender that, in the event of a borrower, which availed collateral-free credit facilities fail to discharge its liabilities to the lender, the Guarantee Trust would make good the loss incurred by the lender up to 50/75/80/85 per cent of the credit facility.
The recent schemes:
The need to analyse these have cropped up because recently Govt made two new schemes to support MSMEs who are facing a huge challenge for survival in the wake of a global pandemic caused by COVID 19 and sharp lockdown imposed overnight without giving time to reduce the activities in an orderly manner.
ECLGS (Emergency Credit Limit Guarantee Scheme): It is a top-up loan for existing borrowers within a cap of Rs 3 lakh crores. The scheme envisages 100% guarantee support from NCGTC.
CGSSD (Credit Guarantee Scheme for Subordinate Debt): This is another scheme to support distressed entities to secure a subordinated debt to the extent of 15% of their contribution and seek a restructuring of the bank loan to revive the business. This scheme is piloted by CGTMSE and the maximum cap is at Rs 20000 crores.
The schemes generated a lot of hope as well as the hype.
Hope because many entrepreneurs who are already reeling under distress due to slowing economy over the last few quarters and sudden lockdown have got a window to stabilise the finances as the loan under the scheme is a cash loan with an extended repayment plan.
It is hype because policymakers have positioned it as the panacea for the entire MSME segment thought the relevance is not inclusive and just top-up for those who are having loans. Further its utility is unlikely to benefit to the fullest extent unless there is a revival of demand for their trade.
The concerns around credit guarantee schemes and its affinity to primary consumers:
There is a proverb. It says every journey should start with the end in mind. This is relevant here for lenders. Because the lenders are the primary consumers of the credit guarantee schemes. After all, they are responsible for the recovery of the money that is lent and they ought to return to the depositors with the promised return.
Hence it is obvious for them (lenders) being concerned about the efficacy of the Credit guarantee with reference to claim settlement to ensure that they get back their money rather depositors money safely.
Claim settlement: The guidelines for settlement of the claims are very much published on their website. What is relevant for how effective it is…….
There are two important issues. One is Guarantor’s insistence for proceedings of staff lapse if any in handling the loan account. The second one is the mandatory filing of the case before the court/DRT before making a claim under guarantee. Another important related issue is lack of access to Bankruptcy Avenue instead of court proceedings.
Many of the ex-bankers whom I have interacted are of the same opinion that CGTMSE seeks confirmation of non-existence of staff lapse within the bank. It is an obnoxious demand because the staff lapse may arise for many reasons not necessarily relating to the loan transaction. Secondly depending upon the banks’ internal proceedings reflects badly on the underwriting standards within the Credit Guarantor’s set up.
Reliance on Banks’ internal process to deal with lapses is the source of uncertainty for the banks to seek a claim from the Credit Guarantor. Thus their appetite for credit guarantee in lieu of collateral security is low. Probably that is the reason bankers are not very enthusiastic about the schemes floated by the Govt.
It is unfortunate that despite being in existence for 20 years CGTSME and NCGTC have not evolved their underwriting standards and rather relying on certain internal processes of lenders having different purposes and outcomes. This is probably hindering the growth of credit guarantee market thus depriving the opportunity for many entrepreneurs to go for orderly capital formation path.
Filing a case for recovery before preferring claims: It reflects the unwillingness of credit guarantor to accept the risk though the guarantee meant to do so. It suggests that the failure of a business is unacceptable. It is a fact that the reasons for failure are not necessarily with the borrower. The industry and economy-related factors will also decide on the performance of a loan account. Another significant issue is there is no enabling provision to deal with the issue under bankruptcy code. Probably that would help to give new lease of life and or quicker resolution than seeking court intervention.
Credit guarantor should have provided a broad range of solutions to deal with events of defaults and the option of fling case should be invoked very discretely.
The Credit guarantee option is very good for entrepreneurs who lack the collateral security to start the venture. However, the Credit Guarantors should do more to convince MLIs who are their primary consumers of the products through modifying their operating guidelines. Being set up exclusively to promote the entrepreneurship among the economically weaker section of the society, they must evolve a broad range of solutions to deal with failures that are endemic to entrepreneurship journey.
MSME Funding Package of Govt of India – A Critical Analysis
MSMEs are offered a financing package to overcome pains from COVID19 lockdown. The package is not universal and likely to have limited impact on the segment.
Govt of India recently announced a scheme for supporting MSMEs who are affected due to sudden lockdown and resultant total disruption of their money flow on account of COVID 19 pandemic.
The package comprises the following:
- ECLGS Scheme -Three lakh crores collateral-free automatic Loans, with a tenure of 4 years, which will have a one-year moratorium on repayment.
- Rs 20,000 crore subordinated debt will be provided for stressed MSMEs under the ambit of CGTMSE.
- To set up a Fund of Fund with an outlay of Rs 10000 that will create a total of Rs 50000 crores of equity for MSMEs
The package apparently sounds very good. It is felt that these measures require critical analysis.
ECLGS Scheme- Three lakh crore loan scheme:
The highlights of the scheme: It is available for those who have SMA 0/1 gradation and obviously SMA2 is not eligible. It is guaranteed by NCGTC, a central govt entity meant to undertake credit insurance activities. The term of the loan is 4 years with one year repayment holiday. It is a cash loan without any requirement of drawing power. The package restricts its relevance for those who are already having a loan as a top-up.
It does not cover those who do not have a loan but require some support to transition through the painful situation and the next two quarters are crucial for them.
It is not a collateral-free loan. Rather it is said that fresh collateral will not be asked. It implies that the collateral security already given will be extended to a new loan and added to that there will be an additional cover of guarantee.
The product is extremely risk-averse: In the event of default, the guarantee cover will be relevant only after executing the recovery action against the securities extended. Against this backdrop, one can easily assume that the relevance of guarantee cover is very minimal. It may be useful to those who already availed under CGTMSE scheme (Maximum of Rs 2 crores).
To set up a Fund of Fund(FoF) with an outlay of Rs 10000 crores that will create a total of Rs 50000 crores of equity for MSMEs
Along with the above, Govt. made an ambitious announcement of setting up funds to provide equity investment to MSMEs. It has proposed to set up an FoF of Rs 10000 crores.
There are two issues here- Mechanism of FoF and past performance of Govt’s FoF
Mechanism of FoF: Whenever I interact with MSMEs they have an impression that Govt will be providing equity capital support of Rs 50,000 crores. Hence I found it is better to clarify the exact position in the matter.
In this scheme, Govt will provide 10000 crores to a notified organisation most likely SIDBI. In turn, SIDBI will invest this money in daughter funds. Here the daughter funds are private equity/venture capital funds set up by private entities. These entities will have to secure 80% of the fund on their own and then only they will be eligible to secure balance 20% from this fund.
In the ideal situation, this should lead to the creation of an equity fund base of Rs 50000 crores.
To check the reality, it is better to review the similar scheme of the Govt in the recent past.
Recent History of Fund of Funds Set up by the Govt of India:
Upon assuming power NDA Govt announced an FoF of Rs 10,000 crores to support startups. Even after six years of existence, the performance of this fund is abysmal.
Under that fund as on 18th February 2020, SIDBI has committed Rs 3,123.20 crore to 47 SEBI registered alternative investment funds (AIFs). These funds have raised a corpus fund of Rs 25,728 crore. This information is shared by none other than Mr Piyush Goyal Miniter of Industry & Commerce.
The Minister’s statement is the pointer to what will be the fate of new FoF that they are proposing.
It is unlikely to garner the interest of PE/VC funds to participate in the FoF because they may not be comfortable with the conditions which are normally associated with Govt money and it is just 20%. Secondly, the impact will be felt in the very long run and not in the immediate future to help MSMEs to beat the challenges from COVID 19.
Rs 20,000 crore subordinated debt will be provided for stressed MSMEs under the ambit of CGTMSE.
Govt proposed a new fund to help MSMEs in distress to revive their business. As per the press statement, each entity will get 15% of their equity capital as subordinated debt to the maximum of Rs 75 lakhs.
It implies that an entity having a capital of Rs 5 crores will be eligible for Rs 75 lakhs. Secondly, it will be restricted to limited companies or may require conversion of the firm into a limited company to become eligible to issue subordinated debt papers to investors (In this case banks).
It is a welcome step for one reason. For the first time, the Govt made an attempt to identify potentially viable firms through policy and fiscal support. Instead of whitewashing the stressed businesses as bad people and emphasising to recover through various means leading to the destruction of the economic value of the enterprises.
However, given the magnitude of the stressed assets in India and the size of the scheme (Rs 20000 crores) is disproportionately low. The govt’s commitment (not necessarily an investment) will be Rs 4000 crores in this scheme.
Govt should lead by committing more own resources:
One thing that is apparent in these measures is that Govt is not providing leadership in the crisis time. Govt has turned risk-averse. Instead, Govt is satisfying itself by creating a scheme that is aiming to transfer the risk on one hand and deflate the interest rate to public depositors whose money banks are supposed to protect. If Govt can’t, the banks which are already having strained balance sheet may not be able to serve with full vigour and assist MSMEs to overcome the challenge from lockdown.
Another point is Govt is abundantly cautious and maybe fearing that the facility may be misused. Against the backdrop of their own fierce campaign against misuse of banking facility during the previous regime, they are treading cautiously, it appears. Secondly, Govt is not parting with money in any of these measures and sounds extremely vary of rating downgrade by the international rating agencies. Hence they are trying to do without expressly committing any monetary support.
The measures announced so far not enough to support the MSMEs segment. It is not universal and not reflective to address the needs in sufficient quantity. If Govt chooses tread carefully, who else will bear with the risk that too when the COVID spread is getting severe.