Arunima Vijay and Shubham Jain

This is the 22nd post of our COVID19 series

Introduction

Ministry of Finance announced the Emergency Credit Line Guarantee Scheme (“ECLGS”) (“Scheme”) to address the impact of Covid-19 on MSMEs as a part of Atma Nirbhar Bharat Abhiyan. The Scheme provides that MSME’s may be sanctioned a loan by the Member Lending Institutions (“MLI”) and obtain additional working capital, and funds to meet the operational liabilities. The amount sanctioned by the central government has the ceilings of loans aggregating to the total amount of INR 3 lakh crore.

The scheme’s framework is similar to that of Pradhan Mantri Mudra Yojana (“PMMY”). PMMY aims to provide easy credit without collateral to small and micro-enterprises. It has a provision to grant loans up to INR 10 lakh under different categories. However, it has also received its fair share of criticism as it has generated NPAs to the tune of Rs 17,000 crore since its inception, along with loan write-offs of about Rs 2 lakh crore. This is because the loans were given without due care, and the borrowers believed that either the government guarantee will be invoked, or the loans will be written-off or waived. Reserve Bank of India had previously raised alarms about the increasing volumes of NPAs arising out of the PMMY. Similar concerns also hold true for ECLGS.

Features of the Scheme

 ECLGS, as notified on May 25, 2020, has, inter alia, the following features:

1. Provision to grant loans to MSMEs of up to an additional 20% of the value of outstanding loans of up to INR 25 crore;
2. The borrower must have an annual turnover of up to 100 crores to be eligible or loans under the Scheme;
3. These additional loans will be 100 percent guaranteed by the Government of India;
4. Moratorium on repayment of the principal amount but not on the interest amount for 1 year, post which, the principal amount is to be repaid in 36 instalments; without any prepayment charges in case of early repayments by the borrower;
5. No additional security is to be demanded by the MLIs, however, a charge over the existing securities pursuant to the existing credit facilities shall be created on pari passu bases within 3 months of the disbursal of the additional amounts.
6. Upon invocation of guarantee by the MLIs, the Trustee Company will pay 75% of the guaranteed amount, and the remaining 25% of the guaranteed amount will be paid upon conclusion of the recovery.
7. The interest rate to be charged by the banks and financial institutions is to be capped at 9.25%, and 14% for the NBFCs;
8. The due diligence requirements vis-à-vis the borrower for the additional loans as provided in the scheme include checking with the credit bureau to get information about the cumulative exposure to the borrower, and determining the viability of the MSME using their banking judgment, and business discretion.
9. The MLIs are required to provide certain information on borrowers inter alia number of eligible borrowers, the amount sanctioned, the amount disbursed, default ratio, NPA ratio on a fortnightly basis to Trustee Company.
10. Borrowers with accounts categorized as standard account, SMA-0, and SMA-1 till February 29, 2020, shall be eligible; whereas the accounts categorized as SMA-2, and NPA shall not be eligible.
11. The banks may not have to make special provisioning arrangements for loans disbursed under the Scheme because the RBI’s approval is being sought to keep the risk weight at zero for the purposes of the Scheme. Currently, the risk weight for MSMEs is pegged at 20%.
12. The scheme extends to the loans sanctioned till October 31, 2020, or till the sanction of an aggregated sum of INR 3 lakh crore under the scheme, whichever is earlier.

Pitfalls and Suggestions

There are concerns that MLIs may be apprehensive towards lending additional funds to the already stumbling MSME sector. Although the Scheme tries to ensure accountability on borrowers as well as lenders, there are certain areas where the Scheme can have substantial improvements. Following suggestions may be considered:

1. Inclusion of a minimum standard of due diligence under the scheme

While eligibility criteria for MSME borrowers for collateral-free loans have been provided within the operational guidelines, no clear due diligence guidelines have been prescribed. The due diligence guidelines under the scheme merely mention requirements such as: [A] checking with the credit bureau to determine the overall outstanding exposure to the borrower; [B] use of prudent banking judgment and business discretion; etc. This is done in order to make it easier for the MSMEs to obtain loan from the MLIs. These requirements are bare minimum and do not suffice the needs of the market amidst these turbulent times as it increased the risk of rash lending by the MLIs since the loans are backed by 100% guarantee by the government. Thus, prima facie, there is no loss to the bank.

It is suggested that a uniform minimum due diligence requirements must be laid down, both before and after lending the additional amount. This will ensure accountability on part of the Lender as it will prevent rash lending. Further, the Borrower will be under constant scrutiny, thereby preventing the chances of default, and thereby, the reliance on the Government guarantee.

The use of ambiguous terms such as prudent banking judgment and business discretion leaves a lot of room for subjectivity. It has been previously noted that banks hesitate to lend because of the fear of accountability and investigation for any lapses in due diligence or otherwise. Often, banks are not reimbursed by the government due to the said lapses.

The following suggestive due diligence guidelines are from the industry practices by banks. These may be incorporated within the scheme:

Before lending:- This may include aspects such as scrutiny of application such as experience, skills, standing/duration in the business, market reports, commercial viability of the project, etc. This would ensure that revenue outlined from a project is sufficient to meet debt obligations and payment of debt is not out of budgetary resources.

After Lending:- To maintain some opportunity to manage their risk after disbursement of additional funds,  continuous monitoring such as visits to the administrative offices, manufacturing units, monitoring cheque bounces, obtaining audit reports, etc. This would also help the MLIs in identifying siphoning/ diversion of funds by the borrowers, if any.

2. A provision to disburse the additional credit line in tranches as per the discretion of MLI

It should be noted here that the purpose of the Scheme is to provide additional working capital in the form of a term loan facility, and enabling MSMEs to meet their operational liabilities and restart their businesses. Therefore, it is also suggested that a provision to disburse loans in tranches (either monthly or quarterly) must be included within the scheme. This will provide MLAs with greater control over the disbursement of funds and maintain higher chances of proper use of the funds, and its repayment. Further, periodical disbursement of funds will allow the MSMEs to survive and meet their operational expenses. If it is observed during the monitoring phase that the project is not able to perform as per the expectations, and fails to generate optimistic returns, the disbursement of the additional funds can be stopped to protect the interest of the MLIs.

3. Shift from an outstanding loan based approach, to projected turnover based approach.

The additional loans have been capped at 20% value of the outstanding loans under the scheme. It is suggested that this approach to sanctioning the additional amounts should be done away with. Since the loans taken by the MSMEs prior to the onset of Covid-19 crises were based on the capital requirements and turnover projections, they did not account for the loss of revenue due to the pandemic and lockdown. However, the capital requirements and market conditions have completely changed and basing the additional loan on earlier estimates would not be reasonable.

It is therefore suggested that sanction of additional amounts should be based on the estimated turnover upon restarting the operations by the MSMEs, once the restrictions of the lockdown are lifted. The estimates may be based on industry standards and projections of losses or increase in turnover based on the nature of industry and projections. This would enable the financial institutions to predict the probability of repayment of the loan better.

4. Clarity regarding loans under PMMY

The Scheme also covers the loans disbursed under the PMMY. However, the borrowers are not required to deposit any collateral or security. Considering, that the MLIs will receive the remaining 25% amount upon completion of recovery of the amount from the borrower, however, in absence of any security, it is unlikely that the recovery of amounts from the borrower can be completed successfully. Therefore, clarity regarding payment of the remaining guaranteed amount from the Trustee to the MLI would also bring more certainty within the scheme

5. Clarification regarding payment of interest

The operational guidelines clearly mention the mode of repayment of the principal amount in 36 instalments, once the moratorium of 1 year is lifted. However, the moratorium does not extend to payment of interest. A two-fold clarification in this regard is required: [A] considering the interest is calculated annually, whether the interest is payable during the moratorium period, or merely calculated; and [B] if it is to be payable; prescribing interval of the payment i.e. monthly/ quarterly would be helpful for the MLIs and the borrowers alike.

Conclusion

The Scheme, although aimed at benefitting the MSMEs, may end up becoming a huge headache for the lenders, as well as the borrower. Therefore, it is important that the problematic areas in the Scheme are catered to. This will ensure that the MLIs can lend without any fear, and the borrowers are certain about their rights and liabilities, thereby helping both the parties involved in the transaction.

The authors are student at the National Law University, Jodhpur.

Picture Credits: Times of India

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