Collateral security is a bane for all entrepreneurs seeking loans from banks and financial institutions. Are there alternatives available
When D Kumar of Andaaz Collections, a Delhi-based readymade garment manufacturer, set about raising a loan from a nationalized bank, he ended up pledging a property, which was valued 13 times
the loan amount, as security to his loan. His first attempt to pledge a property was turned down because the valuation was not high enough to cover the loan. Kumar had to pledge papers of a twin building valuing close to Rs 80 lakh for a Rs 6 lakh loan. While the security was way too high, Kumar had nothing else to offer as collateral and he was running out of time. In the end this collateral got him additional loan of Rs 15 lakh. Five years later, he has launched his exports business and has repaid most of his loan.
Not everyone is as lucky as Kumar. Collateral is a dreaded ten-letter word amongst entrepreneurs. Despite the immense potential locked in small and medium enterprises (SMEs), which largely drive the growth in an economy, many go sick, die prematurely and worse sometimes even cease to exist. All from the lack of finance; caused as banks reject loan requests in the absence of hefty collateral.
|Borrower Category||Maximum extent of Guarantee|
|upto Rs.5 lakh||above Rs.5 lakh upto Rs.50 lakh||above Rs.50 lakh upto Rs.100 lakh|
|Micro Enterprises||85% of the amount in default subject to a maximum of Rs.4.25 lakh||75% of the amount in default subject to maximum of Rs.37.50 lakh||Rs.37.50 lakh plus 50% of amount in default above Rs.50 lakh subject to overall ceiling of Rs.62.50 lakh|
|Women entrepreneurs/ Units located in North East Region (including Sikkim) other than credit facility upto Rs.5 lakh to micro enterprises||80% of the amount in default subject to a maximum of Rs.40 lakh||Rs.40 lakh plus 50% of amount in default above Rs.50 lakh subject to overall ceiling of Rs.65 lakh|
|All other category of borrowers||75% of the amount in default subject to maximum of Rs.37.50 lakh||Rs.37.50 lakh plus 50% of amount in default above Rs.50 lakh subject to overall ceiling of Rs.62.50 lakh|
Raising finance is a big problem that possibly every SME struggles with before making it to the other side of the line of existence. In the microcosmic world of the SME, performance is not the benchmark assuring a loan but a collateral as security for the loan is. That is largely because lenders to SMEs find the industry too volatile and risky to handle.
In India, collaterals form a very significant part of the lending process. "For banks the only criterion an entrepreneur must fulfill is collateral, other aspects like the economic viability and technical feasibility are not half as important, which is why projects often fail," says Apurv Relan of Apurv Relan & Company, a financial consultancy firm.
Determination and evaluation of collateral
While the RBI has prescribed ceilings on collateral as a certain percentage of the loan amount for SMEs, banks follow their own way of determining it.
"We fix the collateral after assessing the entrepreneur's credit rating, risk factor, infrastructure, knowledge, experience and many such factors," says R Satish Shenoy, AGM of Syndicate Bank. "No matter what, we always stress on 100 percent collateral," adds Shenoy.
|CGS - Cost of Cover|
|Credit facility||Upfront one time guarantee fee||
Annual Service Fee
|North East Region (including Sikkim)||Others||above Rs.50 lakh upto Rs.100 lakh|
|Upto Rs. 5 lakh||0.75%||1.00%||0.50%|
|Above Rs.5 lakh to Rs.50 lakh||0.75%||1.50%||0.75%|
|Above Rs. 50 lakh to Rs. 100 lakh||1.50%||1.50%||0.75%|
|CGS – Credit Guarantee Scheme||SOURCE: RBI|
While on the other hand, not pin-pointing the parameters, the AGM of Bank of Baroda JP Sharma said, "We have a long list of about 50-odd parameters on which we assess the entrepreneur before deciding on the collateral amount."
Upon submission of collateral by the borrower, banks evaluate the property. And in case they find it insufficient to sanction the entire amount of loan, they either bring down the loan amount or ask for more, which invariably is the case. For instance, D Kumar of Andaaz Collections had to offer hefty collateral after banks asked for more post evaluation of his property. "For a loan amount of Rs 6 lakh, I had to provide collateral worth Rs 80 lakh," he says.
Criticizing the flawed approach of the banks, Ashok Jain says, "SMEs are mostly private limited, therefore, technically, the liability of the promoter should be limited as well. However, the bank wants him to take more liability. The bank asks for personal guarantee of the promoter and thereby puts his personal assets at stake."
In the absence of collaterals, SMEs often go for unsecured loans for which banks/financial institutions charge heavy interests.
And while desperate entrepreneurs choose higher interest rates to secure funds in order to retain liquidity, they often end up with failed ventures as they struggle to make ends meet.
|From report of the Working Group to review the credit guarantee scheme of the CGTMSE|
|The Group recommends that :|
|(Explanation: Currently, the trust also charges an annual service fee, ranging from 0.50 percent to 0.75 percent per annum, in addition to the normal one-time upfront guarantee fee of 1.0 percent to 1.5 percent of the amount of guaranteed MSE loans. Generally, the average period of cover is about five years and, therefore, the per annum guarantee fee for say, credit facility above Rs 5 lakh, works out to 0.30 percent (1.5 percent divided by 5), which gives a composite all-in-fee of roughly 1.05 percent per annum (0.30 percent plus 0.75 percent). This is very close to the more rigorously worked out annual guarantee fee of 1.14 percent per annum.)|
Collateral-free government schemes
Taking note of the plight of the SMEs, which account for 40 percent of India's domestic production and 50 percent of total exports, the government has started offering collateral-free loans under the guarantee cover of Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE). Under this scheme, banks can lend up to Rs 100 lakh to SMEs, without collateral security or third-party guarantee. The body guarantees up to 66 percent of the loss incurred by banks in case of a default by the borrower.
For this collateral-free loan, the body charges about 1 percent of the credit facility sanction for loans up to Rs 5 lakh and 1.5 percent for loans above Rs 5 lakh from the borrower.
Apart from this there are other schemes too. Under the Credit Linked Capital Subsidy Scheme (CLCSS), borrowers are facilitated with 15 percent capital subsidy for upgradation of technology and under the Technology Upgradation Fund Scheme (TUFS) the borrower is reimbursed up to 5 percent of interest charged by financial institutions/banks for technology upgradation.
However, these schemes hardly find any takers as they involve a lot of paperwork and take long to be processed. Putting it aptly, Apurv says, "The paperwork requirement for the schemes is such that it makes getting loans under them almost impossible."
The other reason why SMEs, despite being refused collateral-free loans don't go for them is lack of awareness. Sudhir Kumar of Eastern Arts Pvt Ltd says, "Banks intentionally don't inform us about such schemes as it means a lot of work for them as well. And again, we entrepreneurs don't have the time to find out about such schemes."
In developed countries
Providing collateral-free loans to SMEs is only possible when the risk associated with them is mitigated. Most developed countries have been able to do that with the help of their government. Government-sponsored insurance programs, covering almost 90 percent of the loan value for smaller amounts, have helped maintain the liquidity of SMEs and this boosted the economy of the countries immensely.
In some countries, a high proportion of SMEs are serviced by guaranteed loans—38 percent in Japan, 20 percent in South Korea, and 20 percent in Taiwan. Most national credit guarantee schemes internationally, however, have little impact on the SME sector (they service only 1-2 percent of SMEs).
|Credit Guarantee can transform India
OS Vinod, CEO, CGTMSE
In the last ten years, since the founding of CGTMSE, we have grown from covering a mere Rs 6 crore to over Rs 14,600 crore as of date. We can do wonders with our mandate and resources.
We are taking steps to change this trend. Last year alone we did 425 programs of which 100 programs were in the North-East and Jammu and Kashmir.
Though our reach is limited, we have made significant strides. Close to 16-17 lakh jobs have been created by CGTMSE's collateral-free loans.
I have always believed that each bank manager is a change agent. Consider this—there are 60-70 thousand banks in the country and if every manager gives one collateral-free loan, we can do wonders.
I always believe that credit guarantee is not a license to lend indiscriminately but to lend responsibly.
The schemes in existence internationally are organized in various corporate or legal forms, ranging from state-operated financial institutions, state-funded companies and government-guaranteed SME loan programs and in some cases independent private corporate entities, credit guarantee foundations or associations, mutual guarantee associations etc (ADB, 2007). One of the largest funds globally, the Korean Credit Guarantee Fund (KODIT) is owned 60% by the national government and 40% by the financial institutions. In Taiwan, the government owns 99% stake in the Small & Medium Enterprise Credit Fund (SMEG) and the remaining 1% is owned by the financial institutions. In the Philippines, however, the Small Business Guarantee & Finance Corp's (national fund) stakeholders are - National Government 45%; 55% by 5 state banks & insurance company. In UK, the Small Firms Loan Guarantee Scheme (SFLG) - National fund is financed 100% by UK Govt. In case of France, SOFARIS (Societe Francaise de Garantie des Financements des petites et Moyennes Entreprises), BDPME Bank (French Development Bank) is the main equity holder and other stakeholders include CDC & French Government.
It is also observed that almost all international major credit guarantee institutions and programs have been granted non-profit status and enjoy exemptions from paying income tax and Value-Added Tax.
Africa has devised a new way of mitigating the risk. Apart from providing financial support to SMEs, banks there also provide non-financial support to try and help them be successful in their businesses. The support program includes mentorship programs, regular free seminars, free budgeting software and more.
Credit guarantee schemes (CGS) have been touted as the savior of the SME sector by governments across the world for decades now. Amongst the Asian countries, South Korea has stood apart in lending under CGS with least losses to the financial sector.
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