Bridging the credit gap for MSMES

‘MSMEs contribute significantly to India’s exports’
| Photo Credit: THE HINDU/M. PERIASAMY

For the longest time, micro, small, and medium enterprises (MSME)s have been at the forefront of India’s economic development. However, this is a sector that has been struggling to survive due to the lack of access to credit and other roadblocks that concern implementation. For instance, provisions such as Section 43B(h) of the Finance Act, 2023, while well intentioned in ensuring timely payments to MSMEs, pose challenges for MSMEs in terms of getting business from third parties. While these concerns exist, the focus of this article is to declutter and address the challenges relating to access to credit for MSMEs.

The MSME sector adds value of around 30% to India’s GDP and accounts for around 62% of the workforce in the business sector, making it the second-largest sector of employment after agriculture. Moreover, MSMEs contribute significantly to India’s exports, accounting for a share of 45.79% of the total value of exports. It is important to note that MSME credit penetration stands at just 14%, which is significantly lower than that of developed economies such as China and the United States, where credit penetration stands at 37% and 50%, respectively. A 2022 report by the Lok Sabha Standing Committee on Finance says that the credit gap in the MSME sector is around ₹20 lakh crore to ₹25 lakh crore, with about 47% of MSME credit demand remaining unmet. There is a need for a proactive approach on the part of the government, along with leveraging advanced technological solutions to bridge this demand.

Existing challenges

As of October 2024, the total number of Udyam registrations (online registration for MSME) stands at 5.19 crore, out of which 5.11 crore are micro-enterprises, 7.22 lakh are small enterprises and only around 68,352 are medium enterprises. That 99% of the total MSMEs account for micro-enterprises that do not have the resources to obtain loans from traditional institutions (which require extensive compliances and collaterals) is a reason for micro-enterprises not getting the loans. Further, the micro-enterprises require small ticket short tenor loans to sustain their working capital, which may not be feasible for banks given the high cost of underwriting. A significant portion of these MSMEs also constitute local shop owners who require additional credit to keep their shops running. To solve this issue, a private Member Bill was introduced by this writer which proposed the creation of fund to cater to the needs of these small shops. However, the larger issue of access to credit still persists.

Further, various initiatives such as the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), the Pradhan Mantri Mudra Yojna and collateral-free loans from scheduled commercial banks (SCB) among others, have been taken to extend credit lines to MSMEs. These are to bring them into the formal financial fold. As far as digital solutions are concerned, the India Stack has been vital in delivering credit and services to MSMEs. Elements such as credit lines on the Unified Payments Interface (UPI) and the Account Aggregator framework enable secure, consent-based financial data sharing to facilitate digital lending. While well-intentioned, these initiatives have not been able to solve the underlying issues with financing MSMEs. The fact that MSMEs become high-risk clients for banks, first, because of low credit ratings and, second, because their loan requirements are different from those of traditional borrowers means that banks and lenders will have to use different methods to supply loans to them. Here, an innovative approach to policymaking that leverages technology and emerging lending models to cater to the requirements of MSMEs could be the way forward.

Digital credit as a solution

Digital lending, poised to surpass traditional lending by 2030, has huge untapped potential in the MSME sector. Scaling existing infrastructure to ‘reach the unreached and bank the unbanked’ is the next step forward. Leveraging Artificial Intelligence and Machine Learning can enhance lending capabilities by creating revenue or cash-flow-based credit profiles. With MSMEs projected to grow in number from 6.3 crore to 7.5 crore, meeting their credit needs will require stronger digital lending systems and collaboration between the public and private sectors.

Trends suggest that MSMEs often seek small ticket loans, with loan ticket sizes offered by public and private sector banks reducing by 21% and 7%, respectively, over the past few years. This trend reflects the change in borrowing preferences of MSMEs, which traditional banking institutions struggle to adapt to. This change in approach can be seen because of the disruption caused by digital lending companies that have revolutionised the way credit is disbursed to MSMEs. Offering collateral-free loans based on information and data as collateral is the new approach to increase credit access to people and businesses in need.

The Fintech Association for Consumer Empowerment (FACE) — the first self-regulating organisation in the fintech sector recognised by the Reserve Bank of India, — reported the disbursement of 2.69 crore loans worth ₹40,322 crore by member digital lending companies in the quarter ending March 2024. Digital lending along with an account aggregator framework will help strengthen fintech to assist financial institutions create revenue-based or cash-flow-based credit profiles, replacing traditional credit assessment. This shall be a significant step in helping make a multitude of micro-enterprises eligible for previously inaccessible loans.

Collaboration as a necessity

In the decade ahead, financial data sharing in India is expected to drive alternative digital financing models at scale, aiding MSMEs in meeting credit needs. Growth will require stronger collaboration between fintech, banks, regulator and the government to build an inclusive lending ecosystem. Government initiatives and traditional lending must complement technological innovation and architecture, creating familiar yet disruptive financial services. Embedding financial services into non-financial sectors such as ride-hailing companies offering loans, can further expand credit access and drive financial inclusion. An incubatory regulatory regime supporting this and other disruptive financial innovations could go a long way in supporting India’s credit inclusion journey.

Ashok Kumar Mittal is Member of Parliament (Aam Aadmi Party), Rajya Sabha