The banks had been pleading with the ministry for a guarantee fund for months as they feared the high-level of non-performing assets and the sudden surge in educational loan disbursements in 2005-06.

Educational loans' portfolio witnessed 50 per cent growth in the past three years. The total outstanding is at Rs 10,004 crore (Rs 100.04 billion). Of which, 70 per cent (Rs 7,000 crore) are loans up to Rs 4 lakh which can be disbursed without the collateral or a third-party guarantee.

Last month, the banking division in the finance ministry had proposed to set up the guarantee fund for educational loans and had asked the Indian Bank [Get Quote] Association to chalk out plans to implement the scheme.

The fund will enhance the comfort level of the banks to sanction loans for higher and technical educational courses without insisting on the collateral or a third-party guarantee.

Educational loans disbursed in 2002-03 will be ready for repayment of equated monthly installments from 2007-08 onwards.

Keeping in view the growth trend and the repayment schedule, the IBA had sought a corpus fund of Rs 700 crore (Rs 7 billion) to meet the probable defaults and to speed up the loan disbursement below Rs 4 lakh.

Based on the past experience, the IBA had estimated that probable defaults could be 10 per cent, which is pegged at Rs 700 crore (Rs 7 billion). 

The IBA had put forth that the government should set aside 50 per cent of the corpus fund and the remaining amount should be advanced by the banks without burdening the student borrowers.

The association had also suggested that the network created by the Credit Guarantee Trust for Small Scale Industries should be utilised while disbursing the educational loans.

This will help save the costs involved in setting up a separate entity for this purpose. CGTSI was set up by the Small Industries Development Board of India to provide the guarantee cover for loans disbursed by the banks to small industries.