As the key driver of economic development, small and medium-sized enterprises (SMEs) play a significant role in running and facilitating the majority of businesses in India and contributing a major chunk of job creation for unemployed professionals and workers. According to the World Bank, SMEs contribute up to 40% of gross national product (GDP) in emerging economies. In India, more than 40 million SMEs – both registered and unregistered – have been engaged in many different sectors such as manufacturing, food processing, packaging, and information technology (IT).

However, unlike big enterprises and firms, small and medium-sized enterprises (SMEs) face many daunting challenges that hinder their proper growth. The most crucial challenges are accessing finance at the right cost and labour support at the right time. Unlike big firms that possess ready cash to fall back on, SMEs solely rely on their working capital to fund all costs. At crunch time, SMEs tend to lower the prices of their products and services below profitable levels and this leads to price imbalance in the market since competitors make things worse for them. In addition, talented professionals in SMES, once they get lucrative opportunities, leave the smaller companies to join bigger firms.

Government Finance Schemes for SMEs

The Government of India had launched MSME business loan, which is defined as a working capital loan, and any businessman can avail of the opportunity to get a loan up to 1 crore in 59 minutes at 8% interest rate. SMEs loans are business loans and are tailor-made as per their requirements. Launched in 2015, the Government of India launched the Pradhan Mantri Mudra Yojana SME loan with the aim of funding unfunded microfinance institutions to reduce jobless economic growth. Under this scheme, a loan of ₹10 lakh can be given to funding non-corporate and micro-enterprises. The period of repayment is between 3 to 5 years, and the average interest rate is 7.3% p.a. Under MUDRA, three schemes were launched – Sishu loan of up to ₹ 50,000, Kishor loan of up to ₹500,000, and Tarun loan of up to ₹10,00,000.

Under the National Small Industries Corporation Subsidy (NSIC) scheme that was launched in 1955, and under this scheme a citizen can avail of funding for raw materials. Small Industries Development Bank of India (SIDBI) offers financial support to MSMEs under SIDBI Make in India Soft Loan Fund for MSMEs (SMILE). The loan provides flexible or soft terms to meet the debt-equity ratio of SMEs. Under this scheme, small and medium businesses are funded with loans between ₹ 10 Lakh to ₹ 25 lakh. Stand-up India which was launched in 2016 provides SME loans to businesses run by SC/ST category people and women to support them initiate entrepreneurship. Under this scheme, the offered loan range is from ₹10 lakhs to ₹1 crore and for funding, every bank must provide this loan to a minimum of one SC/ST man or woman entrepreneur.

SIDBI and the Ministry of Micro, Small, and Medium Enterprises have jointly established the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTSME). Under CGTMSE, people can have collateral-free loans for SMEs who can get loans from any commercial bank or regional bank. Under this scheme, they can get a loan of ₹ 10,00,000. Created in 2008 by merging two schemes – Prime Minister’s Rojgar Yojna and Rural Employment Generation Programme – the Prime Minister Employment Generation Programme is a government-backed credit-linked scheme under which SMEs can get a subsidy amounting to 15-35% of their project cost from the government. SIDBI launched a special scheme to offer financial aid to SMEs that have been engaged in manufacturing medical products or services to fight the global pandemic. Under this scheme, borrowers can get ₹200 lakh without much collateral.

Can SMEs get credit from banks or NBFCs without any collateral?

In order to provide loans for different government schemes, banks do count various options such as working capital loans to long-term asset-backed loans to match the enterprise suitability of an SME. The SMEs borrowers avail of loans up to ₹1 crore without any collateral under the Credit Guarantee scheme. This appears to be a fine option for those borrowers looking for funds to expand their business or meet working capital requirements. But things are not so easy with this scheme since banks can grant loans to only those entrepreneurs who possess proven technical and business acumen. Albeit most Indian banks are reluctant to provide business loans without demanding significant collateral they ask for a guarantor for the loan. For those SMEs entrepreneurs who do not have a reliable guarantor or valuable assets, getting a business loan under this scheme is nothing but a Herculean task. Moreover, banks also do not offer loans to those whose ideas are only on paper.

The Non-Banking Financial Companies (NBFCs) have been a great source of lending for Indian SMEs and they demand minimum documents. They are known for their lenient lending policy and flexible interest rates. It is true that several financial institutions offer small business loans and credits without any collateral. For those SMEs entrepreneurs who are running a successful business, they need, from time to time, more capital infusion, and for this, they entirely depend on bank loans to meet their financial requirements.

National Small Industries Corporation Subsidy

National Small Industries Corporation (NSIC) Subsidy is specially provided to MSMEs. Under this scheme, two kinds of funding benefits are offered: marketing assistance and raw materials assistance. Businesses that fulfill the criteria for micro and small enterprises with EM Part-II / Udyog Aadhar Memorandum are qualified to register for this loan scheme operational under SPRS (Single Point Registration Scheme). Once the enterprises meet the eligibility criteria they can choose a raw material assistance scheme under which financial assistance for both local and imported raw materials is covered. Concerning marketing support, businesses can get funds to bolster their market competitiveness and brand value of the products/services.

Under this government financial assistance scheme, you can get loans for upgrading technology used in production and equipment/machine upgrades. This loan is offered to upgrade the infrastructure. This scheme particularly aims at reducing the costs incurred by enterprises on manufacturing goods or creating services. As per the terms of this scheme, enterprises can get a 15% capital subsidy but the maximum amount offered as a subsidy is set at Rs.15 lakh. For this loan, the eligibility requirement is businesses can apply for sole proprietorship firms, partnership firms, and private and public limited companies.

How can SMEs secure a bank loan without mortgaging their assets?

Collateral means the assets that an SME borrower can give to a lender, which can be a bank or an NBFC (Non-banking financial corporation), for securing the loan. When the borrower defaults in paying the loan, the NBFCs contain the right to seize the collateral that the borrower had surrendered. Collateral-free loans, therefore, are loans for SMEs that do not require any asset from the borrower. In practice, collateral-free loans are easy to get and hassle-free for SMEs and there are institutions in India that offer collateral-free loans for small businesses. For example, ICICI Bank offers collateral-free cash credit and term loans up to ₹2 crores under CGTMSE scheme of SIDBI and the Ministry of Small and Medium Enterprises as defined under Micro, Small, Medium, Enterprises Development Act, 2006. Bank of India offers loans to small businesses under schemes like Star MSME GST Plus Scheme, Star MSME E-Rickshaw, CLCS-TU Scheme, Star Weaver MUDRA Scheme, Star Start Up Scheme, and Star SME Education Plus.

How is the interest rate of SME loans determined by banks or NBFCs?

If we take the interest rates of various banks for SMEs, we understand that State Bank of India charges 8.25% to 16.95% against a loan of ₹500 lakh, while ICICI Bank has varying interest rates against the loan of up to ₹2 crores and Axis Bank comes up with interest rate based on business profile against the loan of up to ₹50 lakh.  Banks are financial players that carry the discretion to determine the interest rate they require against deposits and charge for loans, while doing so they consider the competition and market level into account. Then, there is a board of each NBFC that decides on an interest rate model after considering key economic factors such as cost of funds, margin, and risk premium. The SMEs borrowers know that NBFCs have become preferred lenders since they make quicker decisions, prompt services, and have expertise in niche segments. Unlike banks, NBFCs are without a banking license and hence, are not allowed to accept deposits from the public. Hence, they tend to raise funds through different sources such as bank borrowings and term loans. This is the reason NBFCs often lend loans and credits to SMEs borrowers at higher interest rates hence the present ceiling rate is 12.5%.

The government finance schemes for Indian SMEs have mixed responses though experts feel the trend is optimistic since India likes to raise the contributions of SMEs in the overall development of the country. However, much ease is required on the part of SMEs entrepreneurs who are fresh in the field and who do not have collateral.