Anushruti Singh
The government’s recent announcement of collateral-free loans for micro, small, and medium enterprises (MSMEs) has sparked a wave of optimism and scepticism alike. Union Finance Minister Nirmala Sitharaman unveiled this bold initiative at the National MSME Cluster Outreach Programme, promising loans of up to ₹100 crores backed by a government guarantee. But the question remains: can this move truly address the systemic challenges plaguing MSME financing, or is it merely a step in the right direction without the necessary infrastructure to support its implementation?
With MSMEs contributing approximately 30 per cent to India’s GDP and employing over 110 million people, their growth is pivotal to the nation’s economy. Yet, according to various analyses, inadequate access to finance remains a critical barrier, compounded by high interest rates, procedural delays, and insufficient collateral.
Let’s dive into whether this collateral-free loan scheme is the breakthrough that MSMEs need or just another well-intentioned idea facing implementation hurdles.
Problem with traditional financing
India’s MSME sector has long faced hurdles when it comes to accessing affordable credit. A PwC survey highlights that family and friends, bank loans, overdrafts, and credit lines remain the primary funding sources for these enterprises.
Also, a large number of MSMEs are still excluded from formal lending ecosystems that inhibit their growth. According to the report prepared by the UK Sinha led Reserve Bank of India (RBI) expert committee on MSMEs, the sector has an estimated credit gap of Rs 20–25 trillion.
A majority of MSMEs do not have access to sufficient credit and the liquidity required for daily working capital needs.
Another statistic to digest is high interest rates which are subject to fluctuations, depending on banks, financial institutes, loan types, tenures, etc.
As of January 2025, the average maximum lending rate for MSMEs in India is around 9 per cent, with variations depending on the bank and loan tenure, but typically ranging from 8.5 per cent to 10.6 per cent per annum. This is based on the current MCLR (Marginal Cost of Funds based Lending Rate) rates provided by major banks like SBI, where the one-year MCLR is around 9 per cent. However, our research states that the interest rate could move up to 15 per cent.
This implies that consecutive jumps in interest rates and inflationary pressures have unintended consequences for the availability of credit to MSMEs.
Moreover, a 2023 FICCI survey found that despite the existence of collateral-free credit schemes, banks often demand collateral, reflecting a gap between policy and practice. Despite well-intentioned regulatory measures to address the access to credit challenge for MSMEs, most finance experts believe that the fundamental issue is the implementation gap. However, the Indian market occasionally addresses these gaps with innovative solutions. A key example is credit pricing, where loans are priced based on demand and risk.
Non-Banking Financial Companies (NBFCs), catering to underserved MSMEs, typically charge higher interest rates to offset risks. However, this approach paradoxically increases the likelihood of loan defaults, trapping MSMEs in a cycle of financial strain. As experts observe, the harsh reality might be that certain borrowers will inevitably remain outside the reach of formal banking systems.
So, is the new collateral free promise the answer?
The collateral-free promise
The newly announced government initiative offers loans of up to ₹100 crores without collateral, aiming to address these challenges. This marks a significant departure from traditional risk-averse lending practices, with public sector banks adopting a new credit assessment model.
However, this new loan is not only for working capital and MSMEs can use it for anything they want—like loans for plants and machinery. According to the FM’s statement, the guarantee will be provided, even if you are going to borrow more from the banks. For the first 100 crores, the guarantee will be given.
You don’t even need a third-party guarantee. The government gives you a guarantee for up to 100 crores. However, there’s a small catch. The borrowings will be given on MSMEs credit health assessed on a new model.
Watch Here: New Credit Assessment Model Explained
If you have perused the web story on new credit, it seems to be a solution that will significantly help small businesses to get easy loans regardless of their financial status.
Economic ripple effect
Industry leaders are optimistic about the broader economic impact.
“This scheme directly attacks one of the biggest hurdles that small businesses face, the availability of affordable credit,” says Ashish Bhandari, Founder, EZ Capital.
“Removing a key requirement-collateral, will empower MSMEs to grow, innovate, and positively contribute to the nation’s GDP. That is especially impactful in a post-pandemic economy where many small businesses are merely crawling back,” he adds.
Ajeet Kumar Singh, Co-Founder and Managing Director of SAVE Solutions Pvt Ltd weighs in, saying, “This is a forward-thinking step for MSMEs. This initiative will level the playing field, offering greater liquidity and empowering MSMEs to unlock their true potential. With enhanced access to capital, MSMEs will now be better positioned to grow, diversify, and compete in an increasingly globalised market. This will drive job creation and foster long-term economic development.”
Such optimism is grounded in the potential of MSMEs to unlock untapped economic growth. The gross bank credit deployed to MSMEs under priority sector lending in October 2023 amounted to US$ 279.18 billion, marking a 22.8 per cent increase from the previous year and an 11.8 per cent rise from September 2023, according to the latest RBI data on sectoral deployment.
According to the PwC survey, 40 per cent of MSMEs require loans primarily for working capital. If implemented effectively, this scheme could stabilise their operations and reduce their reliance on informal funding sources.
But there are some hurdles too
Clearly, experts are appreciative of the move, however, some of them have a few reservations as well.
“Removing collateral requirements is a transformative step that can empower countless businesses to access essential financing. For banks, collateral has long served as a safeguard against risk. Shifting to a collateral-free structure will require a major change in how they assess and manage loans,” says Roshan Shah, CEO of VoloFin.
This concern is echoed by the FICCI SME Survey, which advocates for a shift from asset-based to cash-flow-based lending. This approach evaluates a borrower’s ability to repay based on cash flow rather than physical assets, aligning with the needs of many MSMEs operating in sectors like agriculture and retail, where loans are often sought for working capital.
The implementation challenge
According to experts, the success of this scheme hinges on effective implementation. In the past, collateral free schemes like CGTMSE have struggled with adoption due to hesitation from banks.
Bhandari says, “Banks are understandably cautious. Collateral has been their safety net. The new model must include robust monitoring mechanisms to ensure that loans are disbursed to genuine MSMEs, particularly in Tier 2 and Tier 3 cities.”
Another hurdle is the classification of loans as non-performing assets (NPAs). MSMEs often face cash flow delays due to extended working cycles, resulting in defaults under the current 90-day NPA classification. The FICCI survey recommends extending this limit to 180 days to accommodate the realities of MSME operations.
But look at the big picture too!
Globally, innovative financial solutions have enabled MSME growth. Digital lending platforms and mobile money services are reshaping credit access in emerging markets. In India, fintechs and NBFCs have stepped in to fill the gaps, offering scalable solutions tailored to MSME needs.
However, these advancements come with their own challenges. High interest rates and limited risk assessment frameworks continue to plague non-traditional lenders, perpetuating the cycle of credit inaccessibility.
The road ahead requires not just government intervention but also collaboration among banks, fintechs, and industry stakeholders to create a supportive ecosystem for MSMEs. Without addressing structural issues like procedural delays and high interest rates, the promise of collateral-free loans might remain unfulfilled.
