SME Loans

Small and Medium Enterprises (SME) are important for the country’s economic and social development. They play a major role in creating jobs and generating livelihood. Thus, it is vital for the SME sector to have access to financial services, in order to thrive in a competitive environment.

An SME Loan is a type of Business Loan used to fund small and medium-sized enterprises. These loans are customised to the needs and requirements of SMEs. There are many Indian banks that provide SME Loans to these small and medium-sized enterprises. These loans are designed to be in tune with unique requirements which small and medium-sized businesses encounter during various phases of their business.    

 

Which all Businesses are covered under the definition of MSME?

As per PM Narendra Modi’s Vision for an AtmaNirbhar Bharat, the definition of Micro, Small and Medium Enterprises (MSME) in Manufacturing and service sector has been revised to include following:

Manufacturing & Services Sector	Investment in Plant & Machinery	Annual Turnover
Micro Enterprises	Upto 1Crs.	Upto 5Crs.
Small Enterprises	Upto 10Crs.	Upto 50Crs.
Medium Enterprises	Upto 20Crs.	Upto 100Crs.

 

Features & Benefits:

The SME Loan facility has been framed keeping in mind the following objectives:

♦  To improve cash flow to SME sector

♦  To formulate norms and regulations for SME sector to ensure that the adequate and timely credit of cash flow is available to the sector

♦  The SME Loan policy also provides guidelines to the bank branches offering credit/cash flow to the SME sector and to formulate lending criteria for the SME sector

♦  To devise an organisational framework to handle SME credit portfolio in a focused manner

 

Types of MSME Loans:

 

A. Term Loans:

Term Loans are fund-based loans which are given for a fixed term period and the loan is to be repaid by the borrower during the entire term as monthly or quarterly instalments including principal and interest.

Term loans are usually granted to acquire a Business asset or capital expenditure as follows:

 

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1. Machinery / Equipment Loan:

Banks in India provide Terms loans to SMEs for acquiring Machinery within India or for import from abroad. The machinery is usually hypothecated with the Bank. Loans are also given to fund Construction equipment for various infrastructure projects. Tenure of Machinery loans are usually for upto 10 years.

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2. Working Capital Term Loan: 

Many SME business owners have seasonal or cyclical businesses during which they require a working capital term loan to meet the sudden increase in demand for extra capital to meet the seasonal orders. Many Banks provide such Working capital term loans with a repayment period of upto 7 years.

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3. Business Loans (Asset Based):

Unsecured Business Loans are often difficult to get due to the inherent risk involved. Also the maximum amount granted as an unsecured loan is not more than 50lacs. The SME can offer any asset as a security to get a higher Business loan easily. Banks offer upto 100% of the value of collateral security. Asset-backed Business loans also are available at much lower interest as compared to an Unsecured Business Loan. Asset types include - Property, Gold, Equity Shares / Mutual funds, FDs and other business / personal assets.

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4. Business Loans (Unsecured):

An unsecured business loan is a business loan facility that allows a borrower to borrow funds without keeping any asset or mortgage as collateral. Further, since there is no collateral involved, no time is wasted upon collateral verification and documentation. This makes unsecured business loan hassle-free due to easy processing and minimal documentation.

To apply for an Unsecured Business Loans, Click here....

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5. Mudra Loans - Govt. Scheme:

♦  Pradhan Mantri Mudra Yojana (PMMY) is a Government of India initiative, which aims to make credit available to SMEs from the non-agricultural sector. There are three schemes to avail credit - Sishu, Kishore and Tarun. 

♦  An entrepreneur/ business owner can avail credit up to Rs 50,000 under Sishu scheme, up to Rs 5,00,000 under Kishore scheme, and up to Rs 10,00,000 under the Tarun scheme.

♦  Each category of MUDRA loan is unsecured and collateral-free

♦  The funds obtained from each of these schemes can be used to launch new business ventures and fund working capital needs 

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Cash Credit Limit (CC Limit):

♦  It’s a type of revolving credit, which is leveraged by entrepreneurs to fund working capital needs  

♦  It’s a cash credit facility in lieu of current assets of small and medium business owners

♦  Many current assets can be kept as collateral, such as raw materials, stock in trade, unpaid invoices, and account receivable.

♦  SMEs can utilize the CC limit only for business purposes such as purchasing raw materials, power and fuel, buying stocks, etc.

♦  CC limit is given in the form of an overdraft facility.

♦  The amount of overdraft also depends on the value of collateral pledged.

♦  CC Limit is initially given for one year and it is renewed every year based on Audited financial statements and periodic review of current assets.

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Drop-line OD Limit (DOD Limit): 

Dropline overdraft is a facility granted to you where you can overdraw your current account up to an agreed limit and the withdrawal limit reduces each month. This is usually granted against collateral of a Property - Residential or Commercial. DOD against Property is a flexible product offering that allows you a combination of a Term Loan and Overdraft facility. Key Feature are:

♦  Drawing power for the SMEs reduces every month from the initially sanctioned limit unlike the CC limit in which drawing power remains for the full year.

♦  Interest is charged on a daily basis based on actual utilization of funds.

♦  DOD limit is granted for a fixed period upto maximum 15 years.

♦  DOD limit is usually auto-renewed each year unlike a CC limit which has to be renewed every year based on new documentation.

♦  Loan Eligibility is calculated similar to Loan Against Property, but the funds are not released upfront. Rather a drawing power is set in a current A/c and interest is charged at the end of the month on actual utilization of funds.

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Bills Discounting Limit:

The terms ‘bills discounting’ or ‘invoice discounting’ or ‘purchase of bills’ is a source of working capital finance wherein the seller recovers an amount of sales bill from the financial intermediaries before it is due. Such intermediaries charge a fee for the service. Financial intermediaries include banks, financial institutions, NBFCs, etc. Unlike other business loan products, bill or invoice discounting enable business owners to fund working capital needs by converting existing current assets into liquid assets.

The process of bill discounting is quite logical as follows:

♦  The seller sells the goods on credit and raises an invoice on the buyer.

♦  The buyer accepts the invoice and acknowledges paying on the due date.

♦  Seller approaches the Bank to discount it.

♦  The Bank assures itself of the legitimacy of the bill and creditworthiness of the buyer.

♦  The Bank avails the fund to the seller after deducting appropriate margin, discount and fee as per the norms.

♦  The seller gets the funds and uses it for further business.

♦  On the due date of payment, the Bank directly or the seller collects the money from the buyer. ‘Who will collect the money’ depends on the agreement between the seller and the Bank.

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Point of Sale Finance:

With the growth of cashless transactions, digitization and urbanization in our country, many business owners into retail trade are opting for Point of Sale (PoS) systems. Several Banks and NBFCs have started lending credits based on the monthly revenues generated through PoS systems. 

The lender evaluates the creditworthiness of the borrower based on the transaction history of card swipes achieved through the PoS device and working capital loan is sanctioned to the Business owner. Unlike conventional loan products, POS based working capital loans enable business owners to avail credit based on real-time data – monthly debit and credit card sales. 

Following are some of the features & benefits of PoS Finance:

♦  No Collateral security is required to be given

♦  PoS Finance can be obtained from Multiple Lenders - Banks or NBFCs. 

♦  Installation of a PoS Machine is not a mandatory requirement by few NBFCs

♦  Easy repayment options which are short-term in nature of 12 - 18 months.

♦  PoS loans are sanctioned very fast within a few hours at times and avoid the lengthy sanction process in conventional working capital loans.

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Packing Credit, Pre & Post shipment finance for Exports:

Pre-shipment finance or Packing Credit is a type of finance available to exporters prior to shipping the consignment. The exporter submits a letter of credit (LC) in his favour or the export contract with his buyer. Also, the letter of credit must be from the importer for an irreversible transaction of export of goods. On receiving the finance, the exporter uses it in production and packing of the exportable goods. The packing credit for exporters is set based on the value of collateral they provide which can be in the form of a property or a Fixed Deposit. Also, the amount of packing credit is lower of the FOB value of the goods to be exported or their domestic value.

 

Post-shipment finance refers to the credit extended to the exporters after the shipment of goods for meeting working capital requirements. Post-shipment finance can be given to the extent of 100% of the invoice value of the goods exported. 

Post-shipment finance are also called Export Bill Purchased or Discounted  and are extended to an exporter of goods from the date of shipment of goods to the date of realization of export proceeds. Thus, post-shipment finance serves as  a bridge loan for the period between shipment of goods and the realization of proceeds. Such loan is usually provided for a maximum period of 6 months.

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CGTMSE Govt. Scheme:

CGTMSE is an MSME scheme launched by the Government of India to provide collateral-free loans to the existing and new Micro and Small scale industries. The loans are granted for a maximum amount of Rs. 2 crores. 

CGTMSE stands for Credit Guarantee Fund Trust for Micro and Small Enterprises, and as is evident from the name, it is a Trust which provides the financial institutions with credit guarantee to provide loans to SMEs and MSMEs.

Who is allowed to Lend under CGTMSE Scheme?

All scheduled commercial banks (All public sector banks, private Banks and foreign Banks) and SIDBI can be considered as eligible lending institutions. The institutions that enter into an agreement with CGTMSE are called Member Lending Institutions (MLIs).

Who is Eligible to borrow under CGTMSE Scheme:

All new and existing MSMEs are eligible for this credit guarantee who are engaged in following business activities:

 

a. Manufacturing activity

b. Service activity, except:

i. Retail Trade

ii. Educational Institutions

iii. Self Help Groups

iv. Training Institutions

 

Procedure to opt for this scheme?

 

Form a Business Entity: 

The borrower has to form a Business Entity like a private limited company, limited liability partnership, one person company, or a proprietorship firm according to the nature of the business and obtain necessary approvals and tax registrations for executing the project.

 

Make a Business Plan:

Then the borrower has to prepare a Business Plan including the Business model, cash flows, products / services, target customer profile, financial projections etc. The business model should explain the viability of the project. Such reports should be prepared by experienced finance professionals. The finance professional will also identify which lender Bank to approach. The report is then presented to the Credit department of the Bank and an application is filed for getting the loan under CGTMSE scheme.

 

Sanction Process of Lending Bank: 

The Lending bank will check and verify all the details of the application and understand the business model submitted. The Bank will sanction the loan as per its own credit policy and guidelines.

 

Obtain the Guarantee Cover:

After sanction, the bank will further send the application to the CGFTMSE Fund where the application will be scrutinized again. If it is approved the Fund will instruct the bank to release funds for the business. After the approval, the borrower has to pay CGTMSE guarantee and service fee.

 

Meaning:

Bank guarantee means when a Bank offers surety or security for different business obligations on behalf of the borrower. It is a promise made by the Bank to any 3rd party to undertake payment risk on behalf of the borrower.

Bank guarantee refers to a promise provided by the Bank that in case the borrower fails to pay the obligation, then the Bank will take care of the losses. The Bank will assure the creditor that if the borrower does not meet its obligations, then the Bank will have to take care of them.

 

A bank guarantee is a contract between 3 different parties:

♦  The Applicant or the borrower

♦  The Beneficiary to whom the guarantee is given

♦  The Bank who grants this Bank guarantee

 

Uses & Benefits:

♦  To certify the credibility of Business owners which in turn enables them to obtain loans and limits

♦  Small vendors can purchase raw materials, machinery etc. from large companies by providing Bank guarantees.

♦  Service Providers and Contractors can bid for Govt. projects & tenders on the basis of Guarantees from Bank which can be encashed incase they are unable to perform the contract in the future.

 

Types of Bank Guarantee:

 

Financial guarantee: A financial bank guarantee assures that money will be repaid if the party does not complete a particular project or operation entirely. According to the financial guarantee agreement, when there is a delay in the completion of the project, the bank will make the payment.

 

Performance Guarantee: These guarantees are issued for the performance of a contract or an obligation. In case there is a default in the performance, non-performance or short performance of a contract, the beneficiary’s loss will be made good by the bank. For example, A enters into a contract with B for completion of a certain project and the contract is supported by a bank guarantee. If A does not complete the project on time and does not compensate B for the loss, B can claim the loss from the bank with the bank guarantee provided.

 

Bank Guarantee Process and Eligibility:

♦  After formally applying for a Bank Guarantee, the Bank will check the previous Banking history, CIBIL, External ratings, financials and creditworthiness of the Borrower.

♦  The Bank will also check the period for which BG is required, value, beneficiary details.

♦  In some cases, banks can also ask for additional collateral security.

♦  After all credit policy norms are met, the Bank will sanction the BG limit.

Meaning:

A letter of credit is a document that ensures a purchaser’s payment to the seller. It is Issued by a bank and ensures the timely and full payment to the seller. In case the purchaser fails to make the payment to the seller, then the bank will need to pay the entire amount or the outstanding amount that originally needs to be paid by the purchaser.

LC is usually used in international trade of exports and imports in different countries where the parties do not know each other. The importer requests it’s local bank to issue this LC on his behalf, where it is mentioned that the Bank will pay the right amount to the exporter.

 

Uses & Benefits:

♦  LC aids in international trade where due to distances, lack of personal contact and varying laws of countries it is difficult to establish trust between the parties.

♦  LC supports the seller by ensuring receipt of full payments for his delivery of goods.

♦  LC also supports the purchaser in getting a refund for the advance paid to the seller in case he fails to deliver the goods.

 

Types of Letter of Credit (LCs):

♦  Commercial LC: This is the most common type of LC where the Bank directly makes to the seller upon delivery of goods or services.

♦  Standby letter of credit (SBLC): Here the Bank will make payment to the seller only if the Buyer is unable to make the payment itself.

♦  Traveller’s LC: This is used by travellers on foreign trip for personal or official purposes. The traveller’s issuing Bank guarantees to honour drafts that are signed at foreign Bank branches.

♦  Revolving LC: In this, the issuing bank grants an amount for a fixed period of time. During this time, the purchaser can go for any number of withdrawals.

♦  Conf  irmed LC: In this type of LC, 2 Banks are involved. The issuing bank is of the purchaser and there is a confirming bank from the seller’s side. In case the purchaser and its issuing Bank are unable to make payment to the seller, the confirming

   bank has the responsibility of making sure that the payment is done.

♦  Sight LC: In this type, payment is made immediately on sight when the seller furnishes all relevant documents as per the terms of the LC to the concerned Bank.

♦  Irrevocable LC: This type of letter cannot be altered or revoked or cancelled unless every party in the agreement approves to the changes.

♦  Back-to-back LC: This type of letter is useful when there are multiple intermediaries between the buyer and the seller. In this 2 LCs are opened, as this will help both the parties in receiving separate payments.

♦  Deferred payment LC: This type of LC is also called a usance or term LC. In this the seller will get his payment after a fixed time limit even if the all required documents are furnished to the Bank.

 

Letter of Credit - Process and Eligibility:

♦  After the Purchaser provides a LC to the seller, he has to complies with the terms mentioned in the letter of credit document.

♦  The seller is required to deliver the goods to the accurate shipyard. This is when the seller meets all the requirements of the letter of credit.

♦  The delivery documents will need to be sent to the bank so that the bank understands that the requirements have been met. After this step is done, the bank will need to pay the letter of credit without fail.

♦  After delivery of goods to the shipyard, the goods may get damaged due to weather conditions, transportation, mishandling of the package, or any other reason. Even in such situations, the issuing bank must make the payment to the seller as he has completed duty of delivering the goods to the shipyard.

 

Comparison between Bank Guarantee (BG) and Letter of Credit (LC limit):

Key Differences	Bank Guarantee	Letter of Credit
Nature	BG is an assurance given by the bank in case of default by the borrower.	LOC is an obligation accepted by a bank if certain services are performed.
Liability	It arises only when the customer defaults to make payment.	Bank first makes the payment and later collects the same from the customer.
When Payment is made?	Only in situations of a default.	Bank makes the payment as and when it is due.
Who requires it?	Any business transaction.	During import and export.
Risk	Customer assumes the primary risk.	Bank assumes more risk than the customer.

At the time of New SME Loan Application:

Various types of documents are required to submitted at the time of SME Loan Application:

♦  KYC Documents - Identity & address proofs and proof of business

♦  Financial Documents - Audited Balance Sheets and GST Returns

♦  Bank Statements - Current account for 6 - 12 months

♦  Existing loan details - Sanction letters, loan account statements

♦  Property Documents - of Collateral property being offered, if any.

 

Generally the documents required are almost similar across all Banks; however they may differ with various banks depending upon specific requirement etc. 

For a Detailed list of Documents required - Click here....

 

At the time of Renewal of SME Loan Application:

♦  Latest Audited Balance Sheet showing achieved turnover and profits

♦  Stock and Debtor statements

♦  CIBIL check of entity and individuals

♦  Conduct of the Term Loan or working capital limits is checked over the past one year before renewal of the account.

Every Bank or NBFC charges different interest rates for SME Loans. The interest rates vary from 9% and can go upto 24% per annum. Interest rate charged depend on different factors like:

 

♦  Coverage by Collateral property

♦  Type of SME Loan - Term loan, overdraft, fund-based or non-fund-based.

♦  Amount and Tenure of Loan

♦  Borrower’s income profile

♦  Nature of Industry of the Borrower

♦  Ratio analysis of financials

♦  CIBIL rating

♦  External rating

♦  Bank / NBFC internal policies

 

Interest rates of some of the Top Banks & NBFCs in India are:

Name of the Bank	Interest Rate	Loan Amount	Repayment/Tenure
State Bank of India	8.25% to 16.95%	Up to Rs.5 Crs.	Up to 7 years
ICICI Bank	Varies according to type of loan	Up to Rs.2 crore	Up to 7 years
Axis Bank	Based on business profile	Up to Rs.5 crore	Up to 60 months
HDFC Bank	9% to 15%	Up to Rs.50 lakh	Up to 48 months
Bajaj Finserv	18% onwards	Up to Rs.30 lakh	Up to 60 months
Tata Capital	19% onwards	Up to Rs.50 lakh	Up to 36 months

Various of Fees and charges both at the time of loan application and running of the loan are applicable in SME Loans:

 

♦  Processing Fees: Upto 2%

♦  Insurance Charges: For the collateral property

♦  Commitment Charges: For actual utilization less than norms

♦  Penal Charges: For overdue interest upto 3% per month

♦  Annual Renewal charges: Upto 0.50%

♦  Foreclosure Charges: Upto 4%