Credit Guarantee Scheme

A credit guarantee scheme is a program whereby the government aims to support the growth of micro, small, and medium-scale enterprises by providing assured loan facilities to these businesses without the need for keeping collateral or getting a third-party guarantor. While the lenders are ensured of limited credit risk exposure, these business entities can easily secure financing to fund their short—and long-term needs.

The CGS is governed by 16 principles to ensure transparency, integrity, and optimal benefit of the system. These are:

1. Corporate Governance and Risk Management:
   1. Making a solid corporate governance structure led by an independent board;
   2. Precisely state the CGS mandate;
   3. Framing a comprehensive and effective risk management mechanism;
   4. Seeking operational efficiency and integrity through a robust internal control system.
2. Legal and Regulatory Mechanism:
   1. Forming a separate legal entity for the CGS to ensure independence;
   2. Having a mixed ownership structure with proper rights and treatment to minority shareholders;
   3. Extending sufficient funds, transparently disclosing the sources; and
   4. Ensuring effective and independent supervision of the CGS.
3. Monitoring and Assessment:
   1. Periodically disclosing non-financial information publicly;
   2. Getting the financial statements externally audited and setting strict requirements for financial reporting; and
   3. Analyzing the performance of the scheme and disclosing it to the public.
4. Operational Framework:
   1. Determining a consistent, reliable, and transparent risk-based pricing model'
   2. Stating proper eligibility criteria for the lender's MSMEs and credit instruments;
   3. Setting up a robust, efficient, and well-documented claim management process;
   4. Providing a partial guarantee in compliance with the prudential regulations for offering relief to the lenders; and
   5. Ensuring the alignment of such guarantee with the goals of financial sustainability, outreach, and additionality.

The credit guarantee scheme eligibility varies from country to country and scheme to scheme. Some of the basic requirements for availing of such a facility are as follows:

Credit Guarantee Scheme for Startups (CGSS)

As a startup, an entrepreneur needs to ensure the following conditions for being considered for CGSS:

• A business startup should be recognized by the Department for Promotion of Industry and Internal Trade (DPIIT);
• There should be no history of credit default with any loan provider or investing institution, nor shouldn't they have any nonperforming assets;
• The startup applicants should have proof of their stable income stream, I.e., the audited annual or monthly report; and
• The firm should be certified as eligible by the respective member institution to guarantee.

The significance of the credit guarantee schemes for MSMEs, lenders, and the economy can be gauged through the following examples:

Example #1

Suppose a nation has an abundance of iron ore and other metal reserves. However, most foreign companies have established their factories and manufacturing units in this country to benefit from its metal reserves. The government observed that domestic micro and small enterprises fail to compete with these foreign business entities due to a lack of funds. Therefore, the government launched a credit guarantee scheme for all those MSEs that use iron and other metals as raw materials to financially support these budding entrepreneurs and ensure the overall development of the economy.

Example #2

Governments worldwide are raising climate targets to limit global warming to 1.5°C. However, achieving these targets requires a substantial increase in investment, estimated to rise by 700% by 2030. Small and medium-sized enterprises (SMEs) and energy service companies (ESCOs) often struggle to secure financing for energy efficiency projects, such as boiler upgrades or waste heat recovery. Banks view these projects as high-risk, leading to high interest rates and stringent collateral demands.

The Carbon Trust developed a credit guarantee scheme in Thailand to address this issue. The scheme aims to reduce the perceived risk for lenders, providing financial protection and encouraging banks to support energy efficiency projects. By balancing the supply of finance with the demand for credit, the scheme fosters a pipeline of high-quality projects.

In the long run, this initiative supports Thailand's climate goals, with the potential to generate significant returns—an estimated £9 of energy efficiency lending for every £1 of guarantee funds. This effort was part of the ASEAN Low Carbon Energy Programme, active from 2019 to 2023, which helped Southeast Asian countries transition to low-carbon energy by improving access to finance and providing capacity-building support.

The credit guarantee scheme is a systematic funding approach for the MSEs and startups. However, it has specific benefits for lenders as well. Let us discuss these advantages:

• Based on specific guidelines: The CCS is a government-supported initiative that has defined rules, eligibility criteria, and guidelines for lenders to extend loans.
• Limited credit risk: The lenders are exposed to little risk since these are backed by the government, reducing the default risk.
• No collateral requirement: These loans don't require any assets as collateral or guarantor, which makes it convenient for the borrowers to avail of financing.
• Credit flexibility: These schemes help micro and small-scale enterprises acquire short-term and long-term loans as per their requirements.
• Easy availability of funds: Since the eligibility criteria for these types of funds are pre-determined, the MSEs can easily qualify for such funding.
• Low fees: The CGS has minimal annual guarantee charges, reducing the borrowers' financial burden.
• Boosts economic growth: The scheme aims to leverage small entrepreneurs, providing them with an opportunity to create a competent business that would further generate employment opportunities and add to the nation's GDP.