Would You Voluntarily Pledge Gold? 

In a welcome move last week, RBI increased the collateral-free loan limit for Micro & Small Enterprises (MSEs) to Rs. 20 lakhs. Additionally, this limit has been extended to all units financed under the Prime Minister Employment Generation Programme (PMEGP) administered by KVIC. Banks, at their discretion, are also allowed to increase the limit to Rs. 25 lakhs for borrowers with good credit standing.

The changes have been incorporated into the Master Direction on Lending to the MSME Sector, which was last updated in July 2025. The twist, however, lies in one statement. To quote the notification: “However, accepting gold and silver as collateral pledged voluntarily by borrowers for loans sanctioned by the banks up to the collateral free limit, will not be construed as a violation of the above mandate.”

On the face of it, this may appear harmless. But structurally, it creates a serious grey area. 

If a borrower is willing to pledge gold, the borrower can simply get the gold pledged elsewhere and take a loan. Gold loans are among the easiest and fastest ways to access credit. Why should they take the trouble of navigating the MSME loan process  or wait for sanction cycles? 

When gold is introduced into a “collateral-free” MSME loan, the lines begin to blur. Is the loan unsecured in spirit, or merely unsecured in classification? From a borrower’s perspective, the distinction may not be immediately evident. From a risk perspective, however, it makes a material difference. 

While there has been a huge uptake in loans through CGTMSE, the ground reality is that many bankers do not sanction loans even if the borrower is eligible. Credit officers are accountable for NPAs. They are under audit scrutiny. Naturally, they tend to safeguard their books wherever possible. Collateral-free lending is designed to assess enterprise viability, cash flows and creditworthiness rather than asset backing. When an option exists within the regulatory framework, it gradually becomes acceptable practice. What begins as an exception can easily evolve into routine. In such a scenario, bankers may begin to assume that pledging gold is an informal prerequisite rather than a voluntary choice.

This is precisely why the wording of such provisions matters. Policy intent must align with ground-level incentives. The clause permitting voluntary pledging creates room for risk-averse interpretation at the branch level. It is not about accusing banks of wrongdoing. It is about recognising risk and incentives. When an officer has the option of securing additional comfort through gold or silver, the tendency will be to prefer it.

Another large concern, however, lies on the borrower side. Most MSE founders are first-generation entrepreneurs. They are focused on running operations, managing cash flows and meeting deadlines. Regulatory language, master directions and circular nuances are not their daily reading material. There is a clear information asymmetry between the banker and the borrower.

Typical loan documentation runs into pages and terms are often vague to many borrowers. They just sign the pages as instructed by the bankers. In many cases, borrowers are in urgent need of working capital. When funds are required to pay salaries or suppliers, negotiation power weakens. If a bank suggests that pledging gold will “help the process move faster,” very few borrowers will question whether it defeats the spirit of a collateral-free scheme.

All it takes is an additional declaration stating that the borrower “voluntarily” pledged the asset. Technically, the bank is compliant. Practically, the intention is diluted.

In a truly collateral-free framework, there should be no need for voluntary pledging. A policy designed to expand access to unsecured credit should not indirectly normalise secured comfort. The intent of the RBI is unquestionably positive. But if voluntary collateral becomes the norm rather than the exception, the spirit of the mandate weakens.

A good intention can lose its impact because of a loosely framed provision. I truly hope that the RBI will review and tighten this aspect to preserve the integrity of the collateral-free framework.