What Are The Primary Types Of MSME Loans?

Did you know that only 16% of the MSMEs in India have access to formal funding? 

In other words, over 80% of this sector are either underfinanced or are forced to access funds from informal sources, according to an IFC-Intellecap report.

This glaring gap in access to credit not only leads to a wide disparity in terms of tackling debt but also erodes the production capacity of businesses. Unlike large corporates, MSMEs have limited means of external funding. However, India’s credit landscape has improved for these enterprises, slowly but surely, over the past years. 

Multiple options for MSME loans are available today, and there’s a significant thrust in mending the credit gap across the board, from the government to fintech companies.

Types Of MSME Loans

These are the most popular options of financing for MSMEs – 

• Bank Guarantee

Several MSMEs involved with domestic and international trade seek a bank guarantee to meet their funding requirement. In simple words, it is an agreement that involves three parties: the bank, the applicant, and the beneficiary. Usually, the beneficiary has to take the guarantee, while the applicants seek the guarantee. 

You should note that a bank guarantee is just an agreement that assures payment to the beneficiary in case the applicant defaults. An arrangement like this does not depend on the underlying contract or transaction existing between the applicant and the beneficiary. Since the customer initiates such an agreement, the room for maintaining confidentiality is non-existent. 

• Letter Of Credit

You may notice that this funding option is quite similar to a bank guarantee but is not the same. A letter of credit is essentially a contractual promise (irrevocable or revocable as per agreement). A banking institution guarantees that the buyer’s financial obligation to the seller in question will be dealt with utmost care to ensure timely payment. 

They come in handy for accessing funds to boost working capital, especially when payments are slow, like in the case of international trade. You should note that to be negotiable, such a letter must contain an unconditional promise of payment after a definite period or as per the holder’s requirement. 

• Business Loan 

Business loans are among the most sought-after MSME loans these days as more financial institutions are now keen on extending simple repayment terms to small entrepreneurs. Ideally, it is an unsecured credit option that helps you to account for several business-related requirements like –

• Procuring the latest equipment and managerial software systems
• Meeting the cost of expansion or renovation
• Boosting working capital 
• Procuring raw materials or restocking inventory

Some lending institutions also extend customised MSME loans to help them account for their expenses better. But you should note that as this is an unsecured loan, the interest rate and additional charges are relatively high and may not fit every MSME owners’ repayment capability. 

• Bill Discounting

In recent times, bill discounting has emerged as one of the most effective means of raising capital for small businesses. What works out best for enterprises is that such invoices do not necessarily add on to your debt but help to access funds tied up in your accounts receivable, earlier than dated. 

In other words, to avail bill discounting facility, you need to raise your unpaid invoices with an invoice discounting platform. Such platforms discount the bills in question and release a percentage of the bill amount as advances. On maturity, customers repay the dues, and the borrower forwards the balance amount along with the service charge. 

However, you must note that the task of collecting invoice amounts from the customer will rest entirely on your shoulders. Above all, the agreement is usually between the financier and the business owner. This means your customers will not be aware of this whole arrangement (unless you tell them) and you will be able to keep the same confidentiality the entire time. 

Nonetheless, don’t forget to weigh in on the processing and disbursal time. Ideally, top invoice discounting platforms like KredX take around 24-72 hours* to disburse the bill amount. 

• Credit Guarantee Fund Trust For Micro And Small Enterprise (CGTMSE) Scheme

This government-backed initiative was launched to encourage first-time business owners to establish an MSME or SME. It serves as a trust that extends credit guarantees to financial institutions to provide unsecured loans to eligible applicants. Note that CGTMSE guarantees repayment up to a certain percentage in case of default. This scheme lays down eligibility criteria for both lending institutions and borrowers. Furthermore, it does not cover businesses involved with retail trade, training institutes, agriculture, educational institutions, and self-help groups.

Bottom Line

Though several financing options are available to MSMEs these days, entrepreneurs must factor in their repayment capability and financial plan before picking any particular option. They should also compare multiple MSME loans to secure the best bargain in terms of the loan value and interest rate.