Credit Boost For MFIs: Govt Launches Rs 20,000 Crore Credit Guarantee Scheme

The government has launched a Rs 20,000 crore credit guarantee scheme for microfinance institutions (MFIs) to overcome the liquidity problem and for better access to funds. The move comes at a time when many MFIs are facing increased risk provisions and increasing loan write-offs.

The scheme has come into force from March 20 and would be valid until June 30 or till the total guarantee coverage reaches Rs 20,000 crore, whichever comes earlier. It has directed banks and financial institutions to disburse more loans to MFIs by removing their risk exposure.

How Does The Guarantee Mechanism Operate

Under the scheme, member lending institutions like scheduled commercial banks (SCBs) and all-India financial institutions (AIFIs) will get guarantee cover on loans given to MFIs. National Credit Guarantee Trustee Company (NCGTC) will provide coverage for the "amount in default", including both principal and interest.

The amount of guarantee depends on the size of the MFI. Smaller MFIs, with assets under management of less than Rs 500 crore, would get up to 80 per cent cover of the guarantee. Medium-sized MFIs, those with assets in the range of Rs 500 crore to Rs 2,000 crore, will receive 75 per cent coverage. Larger MFIs, which have assets exceeding Rs 2000 crore, will get 70 per cent coverage.

This structure is designed to provide support to the smaller institutions; it is often more difficult for them to access bank credit.

Focus On Fresh Lending

The scheme makes it clear that funds are only to be used for incremental lending. This means that MFIs can use these funds to make new loans to small borrowers as per the definition provided by the Reserve Bank of India. The funds cannot be used to pay the existing loans or liabilities.

To ensure proper use, MFIs must use the funds within three months of receiving them. They are also required to keep separate accounts for the issue of loans under this scheme.

Interest Rate Caps And Benefits To The Borrower

The central government has imposed limits on interest rates to ensure benefits are passed on to borrowers. Banks' lending to MFIs is to cap its interest rates at the external benchmark lending rate or at the one-year marginal cost of lending rate, and an additional 2 per cent per annum.

MFIs, in turn, have to lower their rates to borrowers. They have been required to provide loans at a rate of at least 1 per cent below their average lending rate over the preceding six months.

These measures are aimed at making credit more affordable for small borrowers and ensuring that the scheme benefits the end users.

Rules of Allocation And Loan Limits

To avoid concentration of funds among large institutions, the allocation targets have been set under the scheme. At least 5 per cent of the total loans must be extended to small MFIs, and 10 per cent of the total loans must be extended to medium-sized MFIs.

Loan limits have also been defined based on the size of the MFI. For small MFIs, the loan limit is 20 per cent of their assets, but not more than Rs 100 crore. Medium MFIs are able to borrow up to Rs 200 crore, and large MFIs can borrow up to Rs 300 crore.

The loan period is limited to a maximum period of three years. This includes a one-year moratorium on interest, with a two-year period of repayment.

Solving Sector Challenges

The microfinance industry has been suffering from liquidity constraints in spite of some improvement in the quality of the loan portfolio. Industry estimates indicate that almost five million borrowers have lost access to formal credit over the past period.

There has also been a sharp decline in bank funding to smaller- and mid-sized MFIs, with a fall of around 70 per cent between the fourth quarter of 2023-24 and the third quarter of 2025-26.

The new scheme is due to bring back confidence in lenders and help in the availability of good credit, and help in the growth of the sector.

Operational Conditions And Risk Coverage

Lending institutions will be required to pay a guarantee fee of 0.5 per cent of the sanctioned amount during the first year and 0.5 per cent of the outstanding amount in subsequent years.

In case of defaults, the lenders can make claims every year if an MFI account becomes non-performing. The scheme is based on accountability and is to ensure that funds are being used to create new loan assets rather than support existing exposures.