Credit: Helping the small player | Photo Credit: vkbhat

In March, the government launched CGSMFI-2.0 — a ₹20,000-crore credit guarantee scheme for microfinance institutions. The sector was in genuine distress: bank lending had contracted 8.5 per cent in the first half of FY2026, credit costs had surged to 15.5 per cent, and smaller MFIs were being frozen out.

The scheme was necessary but not sufficient.

This pattern, repeated across sectors, reveals a structural problem. When banks are offered a sovereign guarantee, they do not suddenly lend to the most excluded. Credit flows to larger, better-rated institutions which are already closest to being fundable. A guarantee does not change a lender’s read of the borrower but only changes the cost of being wrong. And if the lender cannot read the borrower at all, the guarantee changes nothing.

Lost MSME decade

Similar dynamics have been at play in MSME lending at a larger scale. The MSME credit gap stands at ₹20-25 lakh crore and has not materially shifted in a decade, despite successive guarantee schemes starting with CGTMSE, established in 2000.

After a decade of voluntary participation and modest uptake, RBI made collateral-free lending mandatory for MSE loans up to ₹10 lakh in 2010. In the same breath, it urged that compliance be made a branch staff performance criterion — an early signal the mandate was already being ignored. Industry bodies later documented banks nudging borrowers to waive their CGTMSE cover so loans could be processed with collateral instead.

In February, the RBI raised that ceiling to ₹20 lakh. Inflation-indexing a broken compass does not show you the true North.

The aggregate evidence is damning. Only 14 per cent of MSMEs access formal credit; nearly 80 per cent remain self-financed or rely on moneylenders. CGTMSE’s data show 93 per cent of its guarantees are for loans below ₹10 lakh — the segment banks were already mandated to serve. The enterprises that genuinely stall — too large for MUDRA, too unfamiliar for commercial banks, sitting between ₹20 lakh and ₹1 crore — remain unserved.

And the lender’s reluctance cannot even be explained by default risk: gross NPAs in the MSE segment stood at under 4 per cent as of March 2024, down from over 9 per cent in 2022. Risk perception and risk reality are disconnected.

Building creditworthiness

What would change this is designing the system such that making borrowers creditworthy becomes someone’s explicit mandate and their measurable reward. The reason banks gravitate to better-rated borrowers, whether MFIs or MSMEs, is that weaker borrowers are simply unreadable: no financial records, no repayment history, no sector data. Guarantees cannot fix invisibility.

Three things are needed: guarantee coverage that actually reaches the missed borrowers (the smallest MFIs and the missing-middle MSMEs); technical assistance paired with those guarantees to build borrower capacity; generate data that shifts the lender’s calculus from fear to evidence; and funded borrower financial literacy, so they can present themselves effectively. Together, these build the track record that eventually makes the guarantee unnecessary — provided guarantee institutions, development finance bodies, and enterprise support organisations work in concert rather than in silos.

We have seen this work. An agri-tech enterprise serving smallholder farmers — the kind that commercial lenders routinely decline — received a guarantee-backed loan of ₹25 lakh paired with structured technical support. Within six months it graduated to a loan without a guarantee. Within four years of that first loan, it listed on the BSE SME Exchange. That listing represented over 50,000 smallholder farmers with higher incomes. It followed from the guarantee structure opening the door, technical assistance building the path, and an enterprise that learned to stand on its own.

The MFI guarantee scheme launched in March will provide necessary liquidity support to some institutions in the short term. The MSME amendments in February are steps in the right direction. But if the pattern holds, the credit gap will look much the same two years or even two decades from now.

Ramanujam is CEO, Villgro Innovation Foundation, and Siva is CEO, Inklude Impact Foundation. Both work on enterprise finance and innovation in India

Published on May 21, 2026