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Lending to Micro, Small & Medium Enterprises (MSME) Sector (Amendment) Directions, 2026

February 09, 2026 4 min read Economics GS3
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What Happened

  • The RBI issued an amendment to its Master Direction on Lending to MSME Sector (RBI/2025-26/206), effective 1 April 2026, mandating that banks must not accept collateral security for loans up to Rs 20 lakh to Micro and Small Enterprise (MSE) units.
  • Banks may increase the collateral-free threshold to Rs 25 lakh based on the borrower's track record and financial position, per their internal board-approved policies.
  • Banks are advised to extend collateral-free loans up to Rs 20 lakh for all units financed under the Prime Minister Employment Generation Programme (PMEGP) administered by KVIC.
  • Banks may avail the benefit of the Credit Guarantee Scheme cover where applicable, and voluntarily pledged gold/silver by borrowers does not violate the collateral-free mandate.

Static Topic Bridges

MSME Classification in India

The MSME sector was reclassified through gazette notifications dated 1 June 2020 and 26 June 2020 (effective 1 July 2020) under the Atmanirbhar Bharat Abhiyaan. The revised classification uses a composite criterion of both investment in plant and machinery and annual turnover, eliminating the earlier distinction between manufacturing and services. Micro enterprises have investment up to Rs 1 crore and turnover up to Rs 5 crore; Small enterprises have investment up to Rs 10 crore and turnover up to Rs 50 crore; Medium enterprises have investment up to Rs 50 crore and turnover up to Rs 250 crore.

  • Governing Act: Micro, Small and Medium Enterprises Development Act, 2006
  • Revised classification effective: 1 July 2020
  • Registration: Udyam Registration (replaced Udyog Aadhaar Memorandum)
  • Udyam registration is online, free, and based on self-declaration
  • MSMEs contribute approximately 30% to India's GDP and 45% to manufacturing output

Connection to this news: The collateral-free lending mandate specifically targets Micro and Small Enterprises (MSEs), which face the most acute credit access challenges due to their limited asset base. By removing collateral requirements for loans up to Rs 20 lakh, the RBI directly addresses the "missing middle" in MSME financing.

Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)

CGTMSE was established jointly by the Government of India (Ministry of MSME) and SIDBI (Small Industries Development Bank of India) in 2000. It provides credit guarantee cover to lending institutions (banks, NBFCs, SFBs) for collateral-free loans extended to MSE borrowers. The scheme covers loans up to Rs 10 crore (enhanced from Rs 5 crore), with guarantee coverage ranging from 75% to 85% depending on the loan size and borrower category.

  • Established: 2000 (by Ministry of MSME and SIDBI)
  • Maximum loan coverage: Rs 10 crore
  • Guarantee coverage: 75-85% of the sanctioned loan amount
  • Udyam Registration mandatory for guarantee cover
  • Annual guarantee fee: varies by loan size (kept low for loans up to Rs 10 lakh)
  • No collateral or third-party guarantee required for covered loans

Connection to this news: The RBI's directive explicitly allows banks to avail CGTMSE cover for the mandated collateral-free loans, effectively transferring credit risk from banks to the guarantee trust. This dual mechanism — mandatory collateral-free lending backed by government credit guarantee — significantly de-risks MSE lending for banks.

Priority Sector Lending (PSL) Norms for MSMEs

Under the RBI's Priority Sector Lending framework, banks must allocate a specific share of their Adjusted Net Bank Credit (ANBC) to priority sectors, including MSMEs. The overall PSL target is 40% of ANBC for domestic scheduled commercial banks. Within this, specific sub-targets apply: 7.5% for micro enterprises. Failure to meet PSL targets requires banks to invest the shortfall in NABARD's Rural Infrastructure Development Fund (RIDF) or similar funds.

  • Overall PSL target: 40% of ANBC
  • Micro enterprise sub-target: 7.5% of ANBC
  • Advances to MSMEs qualify as priority sector lending
  • Banks must also ensure 40% of manufacturing advances go to micro enterprises (having investment up to Rs 1 crore)
  • Shortfall deposited in RIDF at below-market rates (penalty mechanism)

Connection to this news: The collateral-free lending mandate will boost banks' PSL compliance for the MSME sub-target, as more MSE units can access formal credit without the barrier of collateral, thereby expanding the qualifying loan portfolio.

Key Facts & Data

  • Collateral-free loan mandate: up to Rs 20 lakh for MSEs (effective 1 April 2026)
  • Banks may increase threshold to Rs 25 lakh at their discretion
  • CGTMSE maximum guarantee coverage: Rs 10 crore per borrower
  • MSME classification (2020): Micro (investment up to Rs 1 Cr, turnover up to Rs 5 Cr), Small (up to Rs 10 Cr, Rs 50 Cr), Medium (up to Rs 50 Cr, Rs 250 Cr)
  • PMEGP units also covered under the Rs 20 lakh collateral-free mandate
  • RBI notification: RBI/2025-26/206, effective 1 April 2026