NOVEMBER 20, 2018

By Naresh Minocha, Consulting Editor

"CREDIT targets are sometimes achieved by abandoning appropriate due diligence, creating the environment for future NPAs. Both MUDRA loans as well as the Kisan Credit Card, while popular, have to be examined more closely for potential credit risk. The Credit Guarantee Scheme for MSME (CGTMSE) run by SIDBI is a growing contingent liability and needs to be examined with urgency".

This is one of the steps proposed by former RBI Governor Raghuram Rajan in his response to a query on how to prevent recurrence of NPA crisis. The querist is Parliament's Estimates Committee.

Mr. Rajan's timely alert, that hit headlines during last two months, should have prodded the Government to examine the entire business of populism-driven lending. It largely comes in 3 formats: 1) as interest subsidy on loans, 2) as loan write-offs or rescheduling & 3) as guarantees for repayment of loans on behalf of beneficiaries. Guarantees for such collateral-free loans are different from guarantees that Government gives to companies for borrowings from the capital markets.

While there is a Government Guarantee Policy for latter guarantees that was laid in 2010, no policy exists for credit guarantee funds (CGFs).

An enlightened Government must provide guarantees for repayment of loans given to sectors that are prone to high risks of failure. Such sectors are also the backbone of economy and can't thus be left starved of the capital.

Government guarantees for repayment of loans enable banks to lend to difficult-to-lend/highly risky sectors. Such lending is vital for inclusive growth as well as enhancing overall development of the economy.

The problem is not with the guarantees. The problem is proliferation of CGFs without first rolling out policy and regulatory framework.

The sooner the Government acts on this; the better it is for the financial sector stability and the economy as a whole.

How many CGFs exist under the Central and State domains? What is total corpus of such funds? What is the total amount of outstanding, collateral-free loans backed by all CGFs? Such data is not complied at present or at least is unavailable in public domain. Why CGFs should not figure clearly under the current set of disclosures mandated under The Fiscal Responsibility and Budget Management Act?

Should CGFs be operated as off-budget liability? This is done through special purpose vehicles that can be trusts, companies or an apex Government-controlled financial institution such as National Housing Bank (NHB).

CGFs are contingent liabilities that have to be borne by the Government when banks and non-banking finance companies (NBFCs) file claims with CGF administrator when borrowers don't replay loans. Under a CGF scheme, the administrator signs a separate agreement with each bank and NBFC that want to become scheme's member lending institutions (MLIs).

Is the time-lag in recovery of loans, filing of claims by CGF member lending institutions (MLIs) and in settlements camouflaging build-up of new NPA bubble? Is the corpus of each CGF adequate to cover settlement liabilities? Should there not be a cap on over-leveraging by CGF?

Central Government's CGF scheme flagship is Credit Guarantee Trust for Micro and Small Enterprises (CGTMSE). It is over-leveraged with actual corpus of little a little over Rs 2500 crore (the exact, latest figure is unavailable). The corpus would be augmented in phases to a committed level of Rs 7500 crore over a period of unspecified years.

In February this year, an inter-ministerial panel recommended that size of corpus should be enhanced to Rs 12,000 crore keeping in view enhanced lending.

Similar under-funding of corpus exists in case of National Credit Guarantee Trustee Company (NCGTC). It is an umbrella organization for five CGFs with actual corpus of over Rs 5000 crore against committed corpus of Rs 13,000 crore as on 31March 2017. The five CGFs are: Credit Guarantee Fund Scheme for Educational Loans (CGFEL), Credit Guarantee Fund Scheme for Skill Development (CGFSD), Credit Guarantee Fund Scheme for Factoring (CGFF), Credit Guarantee Fund for Micro Units (CGFMU) and Credit Guarantee Fund for Stand Up India (CGFSI). The addition of sixth CGF for start-ups to NCGTC has been delayed apparently for want of requisite approvals.

Another CGF is managed by National Housing Bank. It is called Credit Risk Guarantee Fund Trust for Low Income Housing. It guarantees repayment of loans given to beneficiaries of low-income housing loans. There are a few more central CGFs.

Government guarantees for loan repayments by different beneficiaries is actually a dark zone. It is here pertinent to quote a senior official of Finance Ministry. At an inter-ministerial meeting held during February 2018, he pointed out that "there is no regulatory framework and norms for credit schemes".

He added: "It is desirable that the same is set in place in consultation with IRDA/RBI so that there is appropriate external oversight".

The meeting concluded with a recommendation that the Finance Ministry might explore the scope for preparing regulations for credit guarantee schemes.

This is not the first time that a concern has been voiced over regulatory vacuum in CGFs arena. This subject figured prominently in RBI's 13th Financial Stability Report (FSR) issued during June 2016.

Referring to launch of several CGFs by the Centre and the States, FSR observed: "there may be a need for a proper regulatory framework and supervisory oversight to ensure that their objectives are achieved without resulting in a build-up of huge leverage".

According to FSR, a robust regulatory set-up for the credit guarantee schemes will broadly ensure: i) proper design of the guarantee schemes; ii) risk based pricing of guarantees; iii) proper rules for leverage, solvency, minimum capital requirements, and caps on pay-out ratio; iv) minimum requirements with regard to governance, risk management and internal controls and v) minimum customer service standards.

FSR believes that regulation of guarantee schemes will contribute to their credibility. It would facilitate efficient use of resources in cases where the schemes are supported by public resources.

With proper regulations, guarantee products could become more market-oriented in their design and be less in the nature of social instruments, thus creating space for private credit guarantee companies to enter the market, FSR notes.

It is here pertinent to point out that the World Bank has made Government's regulatory task easier by issuing a report titled ‘Principles for Public Credit Guarantee Schemes (CGSs) for SMEs' in 2016.

The Report's 16 principles are expected to guide country authorities in planning, execution and assessment of CGSs.

Explaining the First principle, the Report says: "A clearly defined legal and regulatory framework for the CGS should have its basis in appropriate and specific legislation. A domestic law or decree should authorize establishment of the CGS, either under corporate or banking legislation or under institution-specific legislation. A sound legal and regulatory framework provides the institutional foundations of the CGS, enhancing its credibility and reputation".

As for 2 nd principle, the report pitches for CGS' adequate funding. It suggests: "to mitigate fiscal risk for the government, the appropriate legislation should put limits on budget appropriations, subsidies, and guarantees. Such limits should accommodate the CGS's policy goals and should be fully consistent with the fiscal resources provided in the government accounts".

Another principle that has direct relevance to Indian situation requires citation. It calls for a comprehensive evaluation of the CGS's performance to account for the use of public resources.

In fact, Modi Government should club credit guarantees with interest rate subsidies/subvention for different sectors to arrive at a total picture of direct and indirect subsidies on welfare. This should be quantified as percentage of both GDP and fiscal deficit.

Let there be a status paper on Use of Budget as fiscally transparent channel for facilitation of affordable loans to under-privileged sectors and communities.