Credit Guarantee Schemes (CGSs) are a frequently employed policy instrument to make it easier for SMEs to receive financing, which, in certain countries, increased in the wake of the 2008–2009 financial crisis. By examining the characteristics of CGSs along a number of dimensions, including ownership structure and funding, legal and regulatory framework, and operational features such as service types, eligibility requirements, guarantee assignment process, and credit risk management, the current study aims to increase understanding of the role, impact, and sustainability of CGSs.
Using in-depth examples from OECD and non-OECD nations, the study examines these factors. In a fast shifting economic and regulatory context, it highlights fundamental and new issues for the financial sustainability as well as the financial and economic additional of these schemes.
Millions of individuals in India have access to employment and innovative possibilities because to micro, small, and medium-sized companies (MSME). More than 63 million MSMEs in India account for more than 30% of the nation’s GDP and are among the biggest employers in the country. An MSMEs is referred to as a nano enterprise, which is a very tiny, unofficial firm run by a nano entrepreneur. Since they frequently lack the advantage of a college degree, it is challenging for them to get employment in the mainstream economy. Their average monthly income is less than Rs 25,000, but they run intricate enterprises with a lot of room for expansion, making them a lucrative market for loans totaling billions of rupees.
Despite the substantial market, traditional bankers and banks have been wary of investing in nano companies. The unstructured nature of nano corporations and their constrained financing needs make it difficult and expensive for traditional lenders to evaluate and support these companies. The lack of reliable information and collateral in nano entrepreneurs is a concern for conventional lenders as well.
Credit guarantees are suggested in this particular case. Due to the absence of data and collateral in this sector, this allows nano businesses to improve their credit ratings. This has the immediate effect of creating a source of cash that nano entrepreneurs can use to grow their companies.
The effects of Funding Nano Entrepreneurs
In response to the pandemic, 80% of MSMEs reduced or temporarily halted operations. Lenders’ capacity to support nano entrepreneurs has been constrained by the concurrent rise in the perceived risk associated with financing MSMEs. In order to account for the increased risk of lending to MSMEs during the pandemic, financial service companies who were experts in providing loan funding to retail NBFCs (that lend to MSMEs) tightened their credit conditions. This was done to stop the infection from spreading. This has an impact on society as a whole, the lives of nano entrepreneurs, and the individuals who work for them.
Businesses that offered specialist finance were able to quickly supply liquid assets and credit up to five times more than before thanks to the credit guarantees they obtained from their partner companies. Additionally, the granting of partial guarantees helped to exceed the capital requirements of retail NBFC borrowers and to lower the risk that was deemed to be related to the provision of loans to such NBFCs. The guarantee providers can increase their appetite for risk with this type of portfolio pooling over a sizable number of partners since it provides them with enough risk diversification.
The Framework for Credit Guarantees
Credit guarantees assist retail NBFCs that lend directly to nanotech businesses and also enable wholesale lenders to continue lending to this industry by enabling them to obtain more funding from conventional lenders. Guaranteed risk protection assists lenders in preserving or boosting their credit scores while building a loan portfolio for MSMEs. Financial guarantees are a way for small and medium-sized firms as well as other high-risk industries to access extra capital.
The demands of India’s small and medium-sized businesses might potentially be met via credit guarantees. By using guarantees to lend to first-time borrowers, NBFCs and financial technology firms might bring this industry into the mainstream of the financial system and dramatically grow its market share.
Additional unsecured loans would be made accessible to the MSMEs and nano sectors once these minor borrowers have successfully repaid their debts. For these debtors, data and credit records will result from this. The ability to re-calibrate the underwriting and credit assessment algorithms used by NBFCs and commercial banks as a consequence would lead to a decreased perception of the risk presented by MSME and nano enterprises. People who have a track record of making on-time debt payments will no longer require the protection offered by a third-party credit guarantee.
The Structure of Credit Guarantees
Banks and non-bank financial corporations (NBFCs) are the two main players in the Indian financial industry. Large banks and financial institutions have the necessary resources and a desire in joining the Indian market, but the country’s regulations and procedures force them to steer clear of taking chances and instead focus on lending guaranteed by collateral. Because of this, these players are unable to meet the small-ticket financing needs of nano companies.
In order to connect with nano entrepreneurs, fintechs and smaller NBFCs may collaborate with community-based groups or have direct interactions with them. Future loans to nano firms may be made available by NBFCs and Fintechs without the need for collateral by constructing new technologies on top of already established alliances.
Though NBFCs that make nano loans have limited access to financial resources as a result of the Covid outbreak, and large lenders are less likely to invest in these small businesses than they once were because major institutional capital sources do not have a high level of confidence in the MSME sector.
By providing some of the risk protection against defaults, credit guarantees allay the worries of big lenders about their exposure to credit risk. Fintechs and NBFCs will have greater liquidity as a result, allowing them to make more aggressive loans to the nano company and MSME sectors. Over 63 million MSMEs in India see business growth as a result of this, which further amplifies the negative effects on businesses and the economy.
This objective has to be achieved in a few different ways. Credit guarantee schemes must be simpler to use and more widely available for financial institutions. Credit guarantees must be provided by a wide range of blended finance providers, such as development financial institutions, impact investors, and nonprofit organisations. To lessen the risk weighting for loan guarantees, this should be investigated. With all of these protections in place, credit guarantees may end up being the first domino to fall, launching a new source of finance for India’s nanobusiness owners.