PSBs Increase Lending to Sub-Prime MSME Borrowers on the Back of Government Guarantees

Mumbai, July 15, 2025: Public sector banks (PSBs) in India are significantly increasing their lending to sub-prime and new-to-credit Micro, Small, and Medium Enterprises (MSMEs). This push is largely facilitated by central government guarantee schemes, which enable PSBs to expand credit access to a segment of borrowers traditionally considered riskier. Sub-prime borrowers are those who do not meet all the criteria for getting a loan or have lower credit scores.

Lending Shift Amid Risk Reduction

Despite a broader trend of reduced sub-prime borrowers across the entire banking system, PSBs are actively targeting lower-rated enterprises. According to the Reserve Bank of India’s (RBI) Financial Stability Report, the share of sub-prime borrowers within banks’ overall MSME portfolios has decreased from 33.5% in June 2022 to 23.3% in March 2025.

However, public sector banks maintain a higher concentration of these riskier loans. As of March-end, sub-prime borrowers constituted 30.3% of PSBs’ MSME books, which is notably higher compared to 18% for private banks and 26.1% for non-banking financial companies (NBFCs).

Government Guarantees Underpin Risk Appetite

This increased lending to sub-prime segments is made possible by key government schemes designed to provide credit protection. These include the Credit Guarantee Fund for Micro Units (CGFMU) and the Emergency Credit Line Guarantee Scheme (ECLGS). Cumulatively, these schemes back approximately ₹6.28 lakh crore in loans. These government guarantees empower PSBs to broaden their underwriting policies, allowing them to extend credit to borrowers who might typically be excluded due to lower credit scores or insufficient collateral.

“PSU banks’ MSME lending is more policy-driven, aiming to include first-time and low-rated borrowers under formal credit. The government-backed guarantees help us manage the risk,” said a senior executive at a state-run bank.

Asset Quality Remains Stable

Despite the increased exposure to potentially riskier borrowers, the asset quality of the overall MSME portfolios has shown signs of improvement. The gross non-performing asset (NPA) ratio for banks’ MSME portfolios declined to 3.6% as of March 31, 2025, down from 4.5% a year earlier. Within the specific guarantee schemes, CGFMU-backed loans registered an NPA rate of 9.9%, while ECLGS loans reported a 6.4% NPA rate. These rates are considered relatively contained given the inherent risk profile of the target borrowers.

Diverging Lending Strategies

In contrast to PSBs, private sector banks are increasingly focusing on super-prime borrowers. These are customers characterised by high creditworthiness and strong collateral. Such borrowers constitute a significant 53.7% of private banks’ MSME portfolios, considerably higher than the 39.3% for PSBs and 35.4% for NBFCs.

Loan pricing also reflects these diverging risk appetites. Super-prime borrowers typically receive loans with interest rates starting from 9%, whereas sub-prime customers are charged between 16% and 24%, depending on the individual lender and risk assessment.

As policy-backed lending continues to evolve, public sector banks are playing a pivotal role in expanding credit access to underserved segments of the economy. They achieve this by strategically balancing increased risk exposure with the crucial support provided by sovereign-backed guarantee mechanisms.

Understanding Key Terms:

• Sub-prime borrowers: Individuals or entities with lower credit scores, limited credit history, or higher perceived default risk, making them less attractive to traditional lenders without collateral or guarantees.
• New-to-credit (NTC): Borrowers who have no prior credit history, making it difficult for lenders to assess their creditworthiness based on past behaviour.
• Credit Guarantee Fund for Micro Units (CGFMU): A scheme launched by the Indian government to provide credit guarantees to lenders for loans extended to micro units, particularly those without collateral. This encourages banks to lend to small businesses that might otherwise struggle to obtain finance.
• Emergency Credit Line Guarantee Scheme (ECLGS): Introduced in response to the COVID-19 pandemic, this scheme provides 100% guarantee coverage to banks and NBFCs for additional funding extended to MSMEs and other eligible businesses, thereby mitigating the credit risk for lenders.

Road Ahead

The path forward for PSBs in sub-prime MSME lending hinges on balancing inclusive growth with financial prudence. With continued support from government-backed guarantee schemes like CGFMU and ECLGS, PSBs are likely to maintain momentum in reaching underserved borrowers and first-time entrepreneurs. However, as the schemes mature and the economy stabilises, banks may face increasing pressure to improve underwriting standards and monitor asset quality more rigorously. Going ahead, digital credit assessment tools, improved borrower education, and tighter monitoring will play a key role in ensuring that the expansion of credit does not lead to future stress in the banking system.

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