SME Loans

Overview & Purpose

Small and Medium Enterprises (SMEs) are considered as backbone for most economies, particularly in developing countries like India. They play an important role in private sector development and the primary driver for job creation, GDP growth and global economic development.

Thus fostering a dynamic small and medium enterprise (SME) sector by providing them the access to financial services, to thrive in a competitive environment is a priority amongst economic development goals in India.

SME loan is available for Small and Medium Enterprise (SMEs) to meet their financial requirements and for business expansion purposes and are specially designed to cater unique requirements which small and medium-sized businesses encounter during various phases of their business. Owing to the significant impact they have on our nation’s economy, much financial help has been extended by Indian private sector lenders in the form of SME loans.

The SME Loan provides a single line of credit for meeting the borrowing needs of SME. It can be used as a working capital as well as for long-term requirements. It is approved after considering the nature of business, cyclical trends, cash flow projections, and peak time requirements.

List Of Businesses Comes Under The Definition Of MSME

Highlights of Features and Benefits of SME Loans

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

Persistent cash flow

To maintain consistent cash flow to the SME sector.

No collateral required

To help SMEs with loans to meet their business requirements without pledging any asset.

Policy formation

To formulate an organizational framework to handle SME credit portfolio in a focused manner.

Competitive interest rates

To offer SME finance at competitive interest rates, so business can reap the rewards with a smarter business loan.

Accessible and convenient

To offer different types of SME loans with various repayment options to avoid facing financial difficulties while servicing the loan.

Highlights of Features and Benefits of SME Loans

A. Working Capital Loans (Fund Based)

Fund Based Working Capital is a limit in which SMEs gets money from banks and financial institutions in revolving credit. There are different types of fund Based Working Capital Loans.

Cash Credit Limit (CC Limit)

To meet capital requirements of SMEs banks give CC (Cash Credit) limit, a type of revolving credit against collateral or pledge of current assets like stock and debtors. SMEs can use the CC limit only for business purposes such as purchasing raw materials, power and fuel, maintenance, buying stocks, etc.

CC limit is given in the form of an overdraft facility and the amount of overdraft depends on the value of collateral assets. This limit is initially sanctioned for one year and reviewed at closing of for renewal subject to business audit reports, financial statements, periodic review of current assets and business requirements.

Drop-line OD Limit (DOD Limit)

  • Every business understands how important is it to have easy access to finances. Irrespective of the size of the business, liquidity crunch in the business is something every SMEs would have confronted and familiar with.
  • Usually banks offer overdrafts as well as dropline overdrafts after taking a collateral security such as property, insurance policies, or other financial instruments like stocks or mutual funds to cover their risk.
  • DOD limit is usually auto-renewed each year unlike a CC limit which renewed every year based on new documentation.
  • Dropline Overdraft is a step ahead of this facility and combines the features of term loans and overdraft facility. In other words, they are long-term overdraft loans that financed for a fixed period upto a maximum of 15 years. Unlike traditional overdrafts, they do not have a yearly renewal charge—only a one-time processing fee, like a term loan.
  • With a business overdraft you can withdraw excess funds up to a pre-determined limit from your bank account, just like a short-term loan. Drawing limit for SMEs reduces every month from the initially sanctioned limit unlike the CC limit in which drawing power remains for the full year. This money can be used for various business requirements like working capital or business expansion and you need to pay an interest on the extra funds used.

Bills Discounting Limit

Most Indian SMEs lack requisite liquidity to acquire goods or raw materials to fulfill more orders, however, buyers demand some credit period which means the business’ working capital will be tied up in invoices for a long time. Working Capital Finance is short-term solution that helps businesses to manage their funding requirements until the time they receive the payment from their foreign buyers. Bill Discounting, which is also known as Invoice Discounting or Invoice Factoring 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 financial intermediaries that include banks, financial institutions, NBFCs, etc charge a fee for the service. 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. This facility is completely unsecured, i.e. it does not need any form of hard collateral unlike conventional working capital solutions served by banks. A collateral-free and speedy working capital solution like Bill Discounting can be a big support in growing your business’s sales as it fuels cash flow which is the lifeline of any growing export business. To understand the process of bill discounting in even more simple way, In Bills Discounting the seller sells the goods on credit and prepares an invoice for the buyer. The buyer accepts the invoice and acknowledges paying the amount on the due date. Now the seller can approach the Bank to discount the bill/invoice. The Bank will do the necessary due diligence to assure itself of the legitimacy of the bill and creditworthiness of the buyer. The bank upon convinced, avails the fund to the seller after deducting right margin, discount and fee as per banks norms. On the due date of payment, the Bank directly or the seller collects the money from the buyer. Who will collect the money from the buyer depends on the agreement between the seller and the Bank.

Point of Sale Finance

As the new age financial technologies driving cashless transactions, SMEs, business owners are opting for Point of Sale Systems(PoS). In India, a number of banks and NBFCs provide Point of sale finance to SMEs where the lending limit is based on real-time data of monthly revenues generated through PoS systems. Many lending institutions even allow borrowers to repay the Point of Sale Finance through either fixed daily installments or daily percentage installments. Here are 7 important things to know about Point of sale finance.
To avail PoS Finance no collateral security is required to be given and loans are sanctioned in a matter of hours at times. Easy repayment options are available which are generally short-term in nature of 12 – 18 months.

Packing Credit, Pre & Post shipment finance for Exports

1. Pre-Shipment Finance:
Pre-shipment Finance or Packing Credit is a loan provided by banks and other lending institutions to SMEs or seller of goods and/or services for the sourcing, manufacture or conversion of raw materials or semi-finished goods into finished goods and/or services, which are then delivered to a buyer.
Once the business has a confirmed order from a buyer, which is backed by a Letter of Credit, the exporter submits that letter of credit (LC) to the lender. On receiving the finance, the exporter uses it for the production 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.

2. Post-Shipment Finance:
Post-shipment finance is also called Export Bill Purchased 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 for meeting working capital requirements. Post-shipment finance can be given to the extent of 100% of the invoice value of the goods exported and usually provided for a maximum period of 6 months.

CGTMSE Govt. Scheme

Availability of bank credit without the hassles of collaterals / third party guarantees would be a major source of support to the SMEs to realise their dream of setting up a unit of their own Small and Medium Enterprise (SME). Keeping this objective in view, Ministry of Micro, Small & Medium Enterprises (MSME), Government of India launched Credit Guarantee Scheme (CGS) so as to strengthen credit delivery system and facilitate flow of credit to the SME sector. To operationalise the scheme, Government of India and SIDBI set up the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).

Under this scheme all new and existing SMEs that carry on manufacturing and service activity except Retail Trade, Educational Institutions, Self Help Groups, Training Institutions are eligible to get collateral-free loans for a maximum amount of Rs. 2 crores. The institutions that enter into an agreement with CGTMSE are called Member Lending Institutions (MLIs).

Procedure to avail CGTMSE scheme ?

By forming a Business Entity:
To avail loans under the CGTMSE scheme the borrower needs to form a Business Entity like a private limited company, limited liability partnership, one person company, or a proprietorship firm and obtain necessary approvals and tax registrations for executing the project.

By making a Business Plan: 
Once the Business Entity is ready then the borrower needs to prepare a Business Plan including the business model, products and services, financial projections etc. The business model has to be in such a way that it should clearly explain the viability of the project. Such reports should be prepared by experienced finance professionals like Chartered Accounts.

Once the report is ready the borrower can then present it to the credit department of the Bank and an application will be filed to avail the loan under CGTMSE scheme.

Sanction Process of Lending Bank: 
Upon filing process is completed, the Lending bank will verify all the details of the application and understand about the business model. Convinced, the Bank is ready to disburse the loan amount as per its own credit guidelines.

Obtain the Guarantee Cover: 
The Bank will then send the application forward to the CGFTMSE Fund where the application will be scrutinized again. If everything goes well and the application is approved, the Fund will instruct the bank to disburse funds to the business. The Borrower has to pay a CGTMSE guarantee and service fee.

B. Bank Guarantee (Non-Fund Based)

Bank guarantee means a Bank gives its promise on behalf of the borrower to 3rd party to undertake payment risk. In case the borrower fails to pay the obligation, the Bank will take care of the losses and resolve the matter with the borrower.

A bank guarantee is a contract between 3 different parties – the borrower, the beneficiary and the Bank.

All Scheduled commercial banks in India can grant non-fund based facilities. With this, traders who import goods and services from abroad can now apply credit facilities in the form of Letter of Credits, Bank Guarantees, all important financial instruments, required to transact overseas mostly, without availing vanilla bank loans.

Types of Bank Guarantee

Financial Guarantee

A Financial Guarantee is given by the Bank to related parties if one business takes on the financial obligation of another business and fails to meet the contractual obligations, the Bank will pay the beneficiary for the loss

Performance Guarantee

A performance guarantee kicks in if services or goods are not provided to the buyer by the seller as per the specifications mentioned in the contract. Performance guarantee is issued by the Bank to the related parties, that in case there is a default in the performance, non-performance or short performance of a contract, the beneficiary’s loss will covered by the bank. After formally applying for a Bank Guarantee, the Bank will check the Banking history and creditworthiness of the applicant or borrower. The Bank will also consider the period for which BG is required, value, beneficiary details, and collateral security if required. If Banks credit norms are met, the Bank will sanction the BG limit.

C. Term Loans

In India, term loans are one of the popular forms of SME loan that are fund-based loans given for a fixed term period and the loan is to be repaid by the borrower during the entire term as monthly or quarterly installments ie (Equated Monthly or Quarterly Installments) that include both principal and interest. The amount, tenure, and interest of the term loan varies between the Banks and other Financial Lenders. Some lenders charge fixed interest rate on term loans, whereas others charge floating interest rate.

Utilization of Term Loans

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

Working Capital Term Loan

Availability of bank credit without the hassles of collaterals / third party guarantees would be a major source of support to the SMEs to realise their dream of setting up a unit of their own Small and Medium Enterprise (SME). Keeping this objective in view, Ministry of Micro, Small & Medium Enterprises (MSME), Government of India launched Credit Guarantee Scheme (CGS) so as to strengthen credit delivery system and facilitate flow of credit to the SME sector. To operationalise the scheme, Government of India and SIDBI set up the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE).

Under this scheme all new and existing SMEs that carry on manufacturing and service activity except Retail Trade, Educational Institutions, Self Help Groups, Training Institutions are eligible to get collateral-free loans for a maximum amount of Rs. 2 crores. The institutions that enter into an agreement with CGTMSE are called Member Lending Institutions (MLIs).

Machinery / Equipment Loan

Many banks in India provide Terms loans to SMEs for purchase machinery within India or to import any other country. Loans are even provided to finance construction equipment for various infrastructure projects. These machines are usually pledged with the Bank.

These loans have a quick processing backed with Government schemes (if applicable/T&Cs apply) and variety of other customized schemes and governments schemes (if applicable/T&Cs apply) are offered as per business requirements. Tenure of Machinery loans are usually for upto 10 years.

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. PMMY enables businesses to avail credit under three distinct schemes – Sishu, Kishore and Tarun.

SMEs can avail credit of 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. All MUDRA loans are unsecured and collateral-free.

Entrepreneurs can use the funds obtained from Mudra schemes to launch new business ventures and to fund working capital needs.

Secured Business Loans

Businesses that are well-established looking for financing usually apply for Asset Backed Business Loans from banks and other lending institutions. But, when a business is in its infant stage with little track record, the owners may have some difficulty obtaining an unsecured loan at a competitive rate due to the inherent risk involved.

The maximum fund allocated to a business as an unsecured loan is not more than 50lacs. SMEs can pledge any asset such as – Property, Gold, Equity Shares / Mutual funds, FDs and other business / personal assets as collateral security with the Bank and obtain upto 100% of the value of the asset. Secured Business Loans also are quite cheaper and cost effective at much lower interest as compared to an Unsecured Business Loan.

Collateral Free Business Loans

An Unsecured Business Loan is a business loan facility that allows a borrower to borrow funds from banks and other financial institutions without pledging any of his asset base. Various banks in India provide unsecured loans to SMEs.

These loans are sanctioned based on the business profile and financial documentations of the borrower. Since there is no collateral involved, no time is wasted upon(legal and technicalities) collateral verification and documentation. This makes unsecured business loan process hassle-free due to quick processing and minimal documentation.

D. LC Limits and Buyers Credit

Generally used in international trade of exports and imports, Letter of Credit is a document that guarantees the buyer’s payment to the sellers. It is issued by a bank and ensures the timely and full payment to the seller. If the buyer is unable to make the payment, the bank will pay the full or the remaining amount on behalf of the buyer. A letter of credit is issued against a pledge of securities or cash. Banks typically collect a fee, i.e. a percentage of the amount of the letter of credit.

LC helps in international trade by ensuring receipt of full payments for his delivery of goods where due to distances, lack of personal contact and varying laws of countries it is difficult to establish trust between the parties. It also supports the purchaser getting a refund for the advance paid to the seller in case the party fails to deliver the goods.

Types of Bank Guarantee

  • Commercial LC: The most popular and common type of LC where the Bank directly makes the payment to the seller upon delivery of goods and services.
  • Irrevocable LC: A type of LC that cannot be altered or revoked or cancelled unless all parties in the agreement agree to any changes.
  • Standby Letter of Credit (SBLC): In case of SBLC the Bank will make payment to the seller only when the Buyer fails to make the payment.
  • Sight LC: With Sight LC, payment is made on sight immediately when the seller submits all relevant documents as per the terms of the LC to the Bank.
  • Confirmed LC: For Confirmed LC, 2 Banks are involved. One is the issuing bank of the purchaser and the other is a confirming bank of the seller. In case the purchaser and its issuing Bank failed to make payment to the seller, the confirming bank will make sure that the payment is done to the seller.
  • Traveler’s LC: This type of LC is used by travelers on foreign trip for personal or official purposes. The traveler’s issuing Bank guarantees to honor drafts that are signed at foreign Bank branches.
  • Revolving LC: Here, the issuing bank finances an amount for a fixed period of time during which, the purchaser can do any number of withdrawals.
  • Back-to-Back LC: This type of LC used when there are multiple intermediaries involved between the buyer and the seller. So, 2 LCs are opened, as this will help both the parties in receiving payments separately.

Process of Letter of Credit

Once the Purchaser of goods and services provides a LC to the Seller, he has to honor the terms and conditions mentioned in the letter of credit. The seller is required to deliver the goods as per the mentioned terms and conditions in the letter of credit.

The delivery documents need to be submitted to the bank so that the bank understands that the requirements have been met. Then bank will pay the letter of credit without fail.

Even if the goods get damaged due to weather conditions, mishandling of the package, or any other reason, the issuing bank must make the payment to the seller as he has completed his part of delivering the goods to the shipyard as agreed in the LC agreement.

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

Documentations Required for New and Recurring SME Loan Application

New SME Loan Application

  • KYC Documents - Identity and Address proofs of Business and Self
  • Bank Statements - Current Account statements for 6 - 12 months
  • Financial Documents – GST Returns Details and Audited Balance Sheet of the Business
  • Property Documents – Details of Collateral Property being offered, if any
  • Existing Loan Details – Details of Existing Loans if taken and Sanction letters issued if any

*These are the most common documents required across all Banks; however banks may require additional documents for specific requirement.

New SME Loan Application

  • Latest Audited Balance Sheet of the Business
  • Stock and Debtor statements
  • Performance of Term Loan or Working Capital Loans of last year
  • Creditworthiness/CIBIL documents

Interest Rates of SME Loans

All scheduled commercial banks charges different interest rates for SME Loans and charges also differ based on business profile. Generally interest rates start from 9% and goes upto 24% per annum. Many factors that influences Interest rates are:

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

  • Value of collateral property
  • Loan amount and tenure
  • Soundness of business’s financials
  • Borrower’s profile
  • Nature of business and its viability
  • CIBIL rating
  • External rating
  • Banks internal policies

Below are Interest rates of some of the top Indian Banks(Rates may change from time to time)

SME Loans Fees and Charges

Fees and charges are applied at the time of loan application and time to time when SME Loan is running.
  • Processing Fees: Upto 2%
  • Insurance Charges: For collateral property
  • Commitment Charges: For actual utilization less than norms
  • Penalty Charges: For overdue interest upto 3% per month
  • Renewal charges: Upto 0.50%
  • Foreclosure Charges: Upto 4%

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