Pratiksha Srivastava
With new interventions by the Government of India; micro, small and medium enterprises are most likely to have a brighter future. The latest update on the MSME sector is the suggestion given by the PHD Chamber of Commerce and Industry (PHDCCI) to the Ministry of Finance. The suggestion is about facilitating MSMEs with collateral-free loans of up to 5 crore rupees and providing a help desk to those seeking loans. Also, registered MSMEs would be taxed at a flat rate of 25 per cent. The Minister of State for Finance, Pankaj Chaudhary, has responded positively to the suggestion and is willing to look into solutions to create possibilities for the same.
Most small businesses have limited credit histories and no substantial assets for security purposes. Thus, getting access to collateral-free loans becomes difficult for small entrepreneurs. Secure financing becomes a complication for such businesses and strengthening or expanding their businesses becomes difficult. Therefore, interventions by the government can act as a boon in such a scenario. If getting access to collateral-free loans of up to 5 crores become possible, then many MSMEs will grow substantially.
According to recent data by the Reserve Bank of India, there has been a rise in the number of defaults among small borrowers along with an increase in the number of bad loans experienced by Indian banks in the personal and micro-credit sectors. Due to this trend, lenders are becoming more cautious, leading to financial constraints in the MSME sector.
To understand collateral security from an expert point of view, we contacted Ram Kumar Singh Thakur, Senior Manager – Accounts at R.S. Agro Chemicals Pvt. Ltd in Bhopal.
He explains, “Collateral security is an additional security along with the primary security offered by the borrower to the bank or other financial institution or lender. It secures your loan where the primary security is not sufficient for covering the loan amount.”
He adds, “This can be regarded as a relief for the lender in case of bad loans. It is a part of cautious loan lending to prevent losses or any fraudulent practices. But it could be difficult for small entrepreneurs or individuals to maintain a collateral along with primary security.”
There needs to be a wider scope for small entrepreneurs so that more businesses can get established. So, if collateral-free loans are introduced for business, then it would be good news for MSMEs.
Collateral-free loans to benefit agriculture sector
Prior to PHDCCI’s suggestions on collateral-free loans, RBI had already announced collateral-free loans on lower interest rates for the agricultural sector. These loans are available to small and marginal farmers and the limit is up to 2 lakh rupees. Farmers can now easily buy seeds, fertilisers, equipment, and necessities for animal husbandry, irrigation, poultry and other farming requirements. Such agricultural loans can be obtained from banks and are also available under government schemes like NABARD, Pradhan Mantri kisan Yojana, etc. These loans are already effective from January 01, 2025, and are ready to support the farmers of the country.
Most farmers do not possess any substantial property to show as collateral security. Therefore, collateral-free loans are supporting them to improve their agricultural businesses and raise their financial standards.
Role of collateral-free loans in education sector
Meeting its education needs is not an easy task for an average family in India. Nowadays, most students plan to pursue higher education at the best institutions, whether inside or outside the country. Collateral-free education loans can be really helpful in such situations. Recently, the State Bank of India (SBI) launched the Ed Vantage scheme’s collateral-free loans with a limit of up to 50 lakh rupees for students looking to study abroad. Such schemes can be a boon for students who do not have any substantial property to show as collateral security. The best part is that the tenure for the repayment of such loans is longer than normal.
Varun Srivastava, a student and resident of Faridabad, Haryana, says, “I will try to get such a loan sanctioned and fulfil my education and career dreams. I hope that the government and financial institutions will open the doors for students who wish to study well and for small entrepreneurs who wish to get established as business tycoons. After all, the young generation is the future and economy shaper of any nation.”
Difference between primary security and collateral security
Although the phrases primary security and collateral are frequently used synonymously in financial contexts, they have different connotations that are crucial to comprehend, especially when discussing loans.
Collateral refers to an asset that a borrower commits to a lender to secure a loan. It is meant to reassure the lender that they will be able to get their money back in the case of a default. Real estate, automobiles, machinery, and even financial items like stocks or bonds are examples of common collateral.
Primary security is a key idea in finance, especially when discussing loans and credit facilities. It alludes to the primary asset or assurance that a borrower offers a lender to obtain a loan. This asset reduces the risk for the lender by acting as the main source of repayment in the case of a default. The loan transaction is intimately linked to the primary security. For example, if a borrower borrows money to buy machinery, the main security is that machinery.
In the event of bankruptcy or default, primary security has a higher legal priority than collateral security. This implies that when it comes to collecting debts, creditors have priority over these assets.
Benefits of collateral-free loans
Businesses are no longer required to pledge assets as security for sanctioning collateral-free loans. MSMEs that have tremendous income potential but may lack significant physical assets will especially benefit from this. These loans make it simpler to obtain the money required for expansion and operating requirements by basing loan approval on creditworthiness rather than collateral.
MSMEs can now invest in vital areas including expansion, technology advancements, and equipment purchases since they can obtain finance without the need for collateral. This funding encourages creativity and keeps companies competitive in a sector that is changing quickly.
MSMEs frequently struggle with cash flow and collateral-free loans offer a safety net by enabling them to control operating expenses without jeopardising their assets. Maintaining a business during lean times or unanticipated downturns requires this stability.
Compared to conventional secured loans, the application process for collateral-free loans is typically simpler and requires less paperwork. More MSMEs are seeking funding because of this accessibility, improving their chances of surviving and expanding in a cutthroat market.
Also, lenders are reassured about the dangers involved with unsecured lending by the government’s support through credit guarantee programmes. In addition to increasing lender confidence, these programmes are helping MSMEs to receive loans more easily.
