Why Do Mudra Loans Have Credit Risks?

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The Indian business sector comprises a majority of Micro, Small and Medium Enterprises (MSME) businesses. Lenders often assume these businesses to be too risky and therefore, these units are often unable to fetch formal business loans. To assist such businesses in raising the necessary capital, the Indian government introduced the Pradhan Mantri Mudra Yojana (PMMY) scheme. The Micro Units Development and Refinance Agency (MUDRA) was established by the government to grant Mudra loans to such MSMEs.

In this article, we will discuss Mudra loans in detail and try to understand why these loans tend to have credit risk attached.

Understanding Mudra Loans

The Micro Units Development & Refinance Agency Ltd. (Mudra) was established in 2015 within the purview of Pradhan Mantri Mudra Yojana (PMMY). The main objective of this agency is to help in developing and refinancing the ‘non-corporate business’ segment by providing support to financial institutions which lend to various micro/small business entities. These businesses must be engaged in either manufacturing, trading or service activities.

Mudra loan aims to use microfinance as an economic development tool which can help in providing various income-generating opportunities to people who are at the bottom of the pyramid. The target population includes small manufacturing units, shopkeepers, fruits and vegetable vendors, truck and taxi operators, food-service units, repair shops, machine operators, artisans and food processors. To know if you can avail a Mudra loan for your business, learn about the eligibility criteria and other aspects of this loan on CreditMantri.

Products Offered in Mudra Loans

Products that can be availed under Mudra Scheme are classified into 3 loan schemes namely Shishu, Kishor and Tarun. Mentioned below are the loan amounts offered under each loan scheme category:

  • SHISHU Loan: Loans of maximum amount Rs. 50,000 (For start-ups and new businesses)
  • KISHOR Loan: Loans ranging from Rs. 50,001 to Rs. 5,00,000 (For purchasing of equipment/machinery, raw materials, a business expansion for existing enterprises)
  • TARUN Loan: Loans ranging from Rs. 500,001 to Rs. 10,00,000 (For established businesses and enterprises)

Credit Risks in Mudra Loans

Recently, there have been indications and talks surrounding the credit risk involved in Mudra loans. The primary driver for such speculation was when former RBI Governor Raghuram Rajan, stated in his report to the parliament that although non-performing assets generated from corporate loans are an existing problem, the government must focus on sources of the next crisis.

The ex-governor also warned that the government should avoid setting ambitious credit targets or loan waivers. He pointed out Mudra loans as ones which pose potential credit risks. He particularly highlighted the culture of meeting rushed targets when the due processes are not carried out and populist sops such as mass loan waivers are adopted.

Credit targets are also achieved by ignoring appropriate due diligence, thus establishing an environment for future NPAs. Mudra loans and the Kisan Credit Card, are very popular but these have to be closely examined for the potential risk that they pose. The report also stated that the Credit Guarantee Scheme for the MSME that is governed by SIDBI is a growing contingent liability and must be examined at the earliest.

Challenges in Repayment

The Mudra scheme loans are offered through three categories and loan amounts range from minimum Rs. 50,000 and maximum up to Rs. 10 lakhs. Nearly Rs. 2.53 lakh crores of the loan amount are known to have been sanctioned for approximately 4.81 crore PMMY loans under all three categories in 2017-18. The average loan size of sanctioned loans stood at Rs. 52,706 for the year.

The State Bank of India announced that it had disbursed Rs. 28,556 crores under the PMMY scheme in FY18. Non-performing assets coming out of this scheme was about 5.2{e5d38099b8d57f54774125ba17c7fc3cb2223b8bcd7edb0d9f116996d199e014} for India’s largest bank. While this comes under the ‘acceptable bracket’ of NPA, there have been rising concerns around the scheme and bank’s approach.

One of the biggest challenges faced under the Mudra scheme is that too many best practices surrounding loan origination tend to be neglected at the time of authorising and disbursing loans. The CBI is also known to have registered a case against a former Punjab National Bank official for abuse of position to sanction and disburse 26 Mudra loans valued at Rs. 65 lakhs.

While business owners may source such loans for genuinely achieving growth and bankers may grant them generously to push the economic development agenda, repayment guarantee is still a major challenge. These loans are unsecured since no collateral is involved that can protect the bank’s interests. The scheme is designed for offering small loan amounts to those who do not have access to funds.

However, sometimes the nature of business of such borrowers may be susceptible to volatility and cyclical trends. For instance, a vegetable vendor may change his business location every second day in the hope of making better profits but could end up having a variable income. Besides, the public banking system often lacks sufficient staff for all the work that such due diligence and payment collection may entail.

Benefits of Mudra Loan

Despite the flaws highlighted around the recovery of Mudra loans, here are some of the benefits that it offers:

  • Mudra loans are primarily offered to shopkeepers, traders, vendors, and MSMEs engaged in manufacturing, trading and service sector activities
  • Mudra scheme comes under the Credit Guarantee Schemes offered by Govt. of India
  • Loan amount granted can also be used as term loans and overdraft facilities
  • All Non-farm enterprises, i.e. small or micro firms involved in the income-generating activities can apply for Mudra loan
  • Mudra scheme can be applied through Mudra cards also

Bottom Line

The Mudra loan, despite being a great initiative by the government for furthering the growth of MSMEs, has several credit risks that might be harmful to the economy in the long run. It is necessary for the government to not just identify these risks but also work towards mitigating them at the earliest.