India is home to nearly 64 million micro, small and medium enterprises (MSME), often called the backbone of our economy. These firms are the growth engine of the country’s economy as they contribute nearly 30% to our GDP and 45% to our manufacturing output.
Despite contributing significantly to employment generation, exports, and GDP growth, access to finance remains a significant challenge for MSMEs, hindering their growth.
Specific actions backed by solid support from stakeholders like centre and state government, fintech startups, NBFCs, and nationalised and private banks are needed to support and empower MSMEs.
Let’s uncover what’s hindering the growth of MSME loans in India and a few solutions to get past this growth blocker to ensure MSMEs get loans more quickly.
An overview of the MSME credit market in India
As per an Avendus report on MSME lending, of 64 Mn MSMEs in India, only 14% have access to credit compared to 30%+ in developed nations.
Out of the total credit demand of USD 1,955 Bn, only USD 289 Bn is currently met by formal sources of credit, i.e., private banks (45%), public banks (43%) and NBFCs (12%). This brings us to a large credit gap, providing considerable whitespace for greater lending in this segment.
The challenge is even greater for the small ticket loans of INR 1 Mn and lesser, where only 30% of this credit demand is met, and the credit gap is estimated to be close to USD 120 Bn.
Of these, micro-enterprises are the worst hit. In 2021-21, 40% of micro-enterprises were denied lending for lack of collateral.
Factors influencing the MSME loans market in India
The factors that hamper MSME loan growth are
- Lengthy turnaround time for receiving credit,
- High interest rates,
- Inability to showcase strong financial health.
To understand the MSME credit market in India, it is essential to consider key factors that can significantly influence the market.
1. Interest rates: Interest rates significantly determine the demand for MSME business loans. A lower interest rate can attract more borrowers and increase loan demand, while a higher interest rate can decrease need.
2. Economic growth: The demand for MSME loans in India is closely tied to economic growth. When the economy grows at a higher rate, there is more business activity, leading to an increased demand for credit.
In 2023-24, India’s economy is projected to expand by 6.5%, likely driving up the demand for MSME loans.
3. Technological advancements, includingalternative data sources and credit assessment models to provide loans to MSMEs, have revolutionised the lending industry, making it easier for borrowers to apply for loans and lenders to process applications.
The emergence of fintech companies has made it easier for MSMEs to access credit and is expected to further increase demand for MSME loans in 2023.
lnnovations in financing for MSMEs
| 1. Alternative Credit Scoring | These methods analyse factors like payment history, bank balance, and spending patterns to determine creditworthiness. |
| 2. Bank-fintech partnership model | Banks partner with Fintech companies in industries like travel, food and hospitality to identify and assess potential borrowers. |
| 3. Captive models | Some companies from different industries are now venturing into lending to offer loans to their loyal customers. This is done by creating their own NBFCs or collaborating with established financial institutions. |
| 4. Crowdfunding/P2P | Crowdfunding is a method of obtaining funds online from numerous individuals. Entrepreneurs present their business ideas, and potential investors can select which projects to fund. Each investor contributes a small amount of money, which is then utilised to support the business. |
| 5. Digital Mortgage | These lenders have streamlined obtaining mortgage loans by digitising every step, from the initial application to credit underwriting and loan delivery, reducing the time it takes to complete the process and improving the overall experience for customers who can now access these services online. |
| 6. Line of credit | A line of credit is a flexible account that lets you borrow, repay, and redraw funds as needed. |
| 7. Loan marketplaces | They connect borrowers with financial institutions, and their digital supply chain guarantees borrowers a seamless and hassle-free experience, making it the perfect platform for an MSME’s financial needs. |
| 8. Invoice discounting exchanges | They allow SMEs to discount unpaid invoices to a network of financiers such as banks, NBFCs, wealth managers, and retail investors. |
| 9. Revenue Based Financing (RBF) | With this type of financing, a company receives funds in exchange for a percentage of its future revenue. The amount owed is based on a percentage of sales, which can be a more flexible and manageable option for many businesses. |
| 10. Supply Chain Financing | NBFCs that provide direct lending services collaborate with wholesale players and marketplaces to reach a vast network of merchants purchasing their products from these platforms. These marketplaces have a wealth of data on the sales patterns of these merchants, creating sophisticated models for credit assessment analysis. |
Government measures for easing access to credit for MSMEs
Various measures have been taken to increase access to credit for MSMEs in an affordable manner, including
- The revised criteria for classifying MSMEs based on investment size and turnover are introduced.
- ‘Udyam Registration’ for MSMEs for ease of doing business.
- The inclusion of retail and wholesale traders as MSMEs.
- Rolling out of Pradhan Mantri Mudra Yojana (PMMY) scheme to provide collateral-free access to institutional finance to unfunded Micro/Small business units with loans up to INR 10 lakhs.
- In the wake of the Covid-19 pandemic, Emergency Credit Line Guarantee Scheme (ECLGS) supports eligible MSMEs and business enterprises in meeting their operational liabilities and restarting their businesses.
- The psbloansin59minutes portal was introduced to facilitate in-principle approval of loans of up to INR 5 crore to MSMEs without human intervention.
- Trade Receivables Discounting System (TReDS) has been operationalised to alleviate the problem of delayed payments to MSMEs.
- RBI has ordered banks to link all new floating rate loans to external benchmarks for MSEs and medium enterprises for better monetary policy transmission.
- Target of 7.5% of Adjusted Net Bank Credit (ANBC), or credit equivalent amount of off-balance sheet exposure, whichever is higher, fixed for SCBs for lending to micro-enterprises under priority sector lending (PSL) norms.
Adopting new ways to boost MSME credit
The MSME credit market is expected to reach INR 16.3 trillion in 2023, up from INR 14.3 trillion in 2022. India can implement several measures to ensure that (MSMEs) can obtain loans more quickly.
Below are some strategies lenders and governments can adopt:
1. Simplify loan application processes: To simplify loan applications for MSMEs, lenders can streamline the process by reducing documentation requirements, digitising forms, and providing clear guidelines.
Additionally, lenders can develop alternative credit assessment models that consider non-traditional factors such as cash flows, providing a more accurate evaluation of creditworthiness.
2. Collateral-free and guarantee-backed loans: Offering loans without collateral or with reduced requirements can help small businesses access credit more quickly.
Credit guarantee programs like CGTMSE can provide guarantees to lenders, promoting loans to those with limited collateral or credit history and improving financial opportunities.
3. Encourage digital financial inclusion: To increase financial inclusion, digital payment systems and online platforms should be more accessible. Encouraging MSMEs to use digital transactions can help establish creditworthiness.
4. Promote fintech solutions: Fintech can help MSMEs with unique requirements using alternative data sources and risk assessment models.
A mindful collaboration between traditional financial institutions and modern fintech companies can improve lending services.
5. Capacity building and financial literacy: Governments and industry bodies can help MSMEs improve their financial management skills through capacity-building and financial literacy programs. This can increase their creditworthiness and chances of obtaining loans from lenders.
6. Policy reforms and strengthening institutional support: To support MSMEs better, governments can establish dedicated help desks or specialised branches in financial institutions.
Collaboration between government, financial institutions, industry associations, and MSMEs can create innovative financing models and platforms.
Governments can also continuously review policies and regulations to identify and address bottlenecks. They can provide incentives like tax breaks, interest rate subsidies, or reduced loan fees to encourage lending to MSMEs.
Conclusion
To facilitate India’s economic progress, it is crucial to simplify the process for MSMEs to obtain loans.
Effective tactics can be employed to overcome the obstacles that impede MSME loan growth, such as streamlining loan application procedures, advocating for collateral-free loans, promoting digital financial inclusion, encouraging fintech solutions, improving capacity building and financial literacy, and implementing policy changes.
India can encourage stakeholder cooperation and regularly assess and enhance policies to empower MSMEs to realise their full potential and become the leading force behind economic expansion.
Author – Subhashish Bhadra, Head of Corporate Development, Klub
