MSMEs in India face multiple challenges in accessing formal finance
The New Delhi Leaders’ Declaration, recently adopted at the G20 Summit, recognizes startups and Micro, Small, and Medium Enterprises (MSMEs) as the natural drivers of economic growth. It also acknowledges MSMEs as the key to socio-economic transformation and has recommended the need to foster their growth. In a country like ours, where MSMEs employ more than 11.10 crore people, constituting the second-largest workforce sector, and contributing over 30% to the GDP, this recognition goes beyond being a catchphrase. It reiterates the need to nurture the MSME sector if we want to achieve our ambitious goal of a $5 trillion economy.
MSMEs form the backbone of the country’s industrial and entrepreneurial ecosystem, contributing significantly to economic growth, job creation, and regional development. They play a pivotal role in promoting inclusive growth by providing employment opportunities, fostering entrepreneurship, and facilitating the equitable distribution of wealth. In essence, MSMEs are not only engines of economic growth but also essential vehicles for social and economic empowerment in India.
Initiatives such as categorizing MSMEs as a Priority Sector for Lending (PSL), Udyam Registration Portal, unified Goods & Services Tax (GST), and increased access to tech solutions such as digital payments and e-commerce, have nudged MSMEs towards formalization and growth of their businesses. However, challenges such as complex regulations, rising costs, and limited access to formal credit persist. In fact, even today, only 38% of the estimated MSMEs have ever availed credit from formal sources.
The MSME Financing Challenge
MSMEs in India face multiple challenges in accessing formal finance. Cumbersome documentation requirements, collateral demands, and lengthy loan approval processes have hindered their access to formal business loans. MSMEs are often grappling with soaring operational costs due to various macro-economic issues. Increased expenses for raw materials, overhead, processing, and energy underscore the pressing need for financial institutions to support capacity expansion and technology upgrades.
The CRISIL MI&A Research’s biannual MSME Report indicates that India’s MSMEs, which contribute to 40% of the country’s exports, will encounter challenges in FY24 due to an impending economic slowdown in advanced economies like the United States and the European Union. Approximately one-fifth of the MSME sector will experience an increase in working capital requirements, especially in sectors such as dyes and pigment, gems and jewellery, and construction. MSMEs require over ₹100 lakh crore in debt, with 70% allocated to working capital, primarily informally sourced, incurring high costs and compromising the financial health of the businesses.
The Role of NBFCs in MSME Financing
Non-Banking Financial Companies (NBFCs) hold a pivotal position in the landscape of MSME financing, primarily due to their ability to offer a wide array of financial products and services tailored for the diverse needs of these enterprises. NBFCs can craft bespoke lending solutions such as collateral-free short-term working capital, collateral-free long-term working capital, supply chain financing, machinery purchase loans, addressing the unique challenges faced by MSMEs. Their flexibility in lending criteria is another advantage, allowing them to consider factors beyond conventional collateral and credit histories, such as cash flow patterns and future growth prospects, thus widening the scope of accessible financing for MSMEs.
NBFCs successfully bridge the geographical gap that often hampers MSMEs’ access to formal financing. With a strong presence in Tier 2 and Tier 3 cities, and even remote rural areas, many NBFCs have made it possible for MSMEs across various regions to easily access financial services. NBFCs have also been at the forefront of fintech integration, leveraging digital platforms to streamline the lending process. Online lending products and services have gained popularity, enabling MSMEs to apply for loans quickly and conveniently, often receiving funds within days, a vital feature for enterprises in need of prompt capital infusion. In this context, NBFCs have emerged as key players in facilitating MSME financing and driving economic growth.
Leveraging Digitization and Emerging Tech
NBFCs have brought about a transformative shift in the realm of MSME lending. On one hand, they have revolutionized credit risk assessment with the use of new-age technologies like AI/ML. Leveraging technology, NBFCs have been able to look beyond the CIBIL score and instead can assess creditworthiness on a multitude of factors like GST, UPI transactions, etc., which in turn has helped in bringing many new-to-credit MSMEs to the fold of formal credit. They have mainstreamed the concept of collateral-free loans, shortened the processing timeline to as little as 48 hours, and introduced flexible repayment options tailored specifically to suit the requirements of small businesses.
NBFCs are also ideally positioned to adopt emerging technology to further the financial inclusion of MSMEs. For instance, NBFCs are at the forefront of adopting embedded finance wherein customized financial services can be integrated into non-financial platforms. Embedded Finance in India is expected to grow at a CAGR of 36%, owing to agility both in terms of technology adoption and creating customized products. NBFCs are well poised to leverage the opportunity and fast-track access to credit further.
Through a strategic blend of technology and a profound understanding of MSME customer requirements, NBFCs have crafted flexible lending criteria, expedited loan approval procedures, and bespoke financial products designed specifically for small enterprises. This adaptability and customer-centric ethos have yielded highly positive results, with NBFCs experiencing a significantly higher growth rate in their MSME portfolios compared to traditional banks.
The power of Strategic Collaborations
Collaboration within the banking sector is vital to creating a more supportive ecosystem for MSMEs, and NBFCs have been at the forefront of driving partnerships. This collaborative approach can help NBFCs meet the evolving needs of MSMEs, thereby driving economic growth in this underserved sector.
For instance, co-lending partnerships have demonstrated the enormous potential that partnerships can bring to the table. In addition, NBFCs can get access to cost-effective financing from banks, bolstering their lending capacity and helping them to meet the surging demand for MSMEs. For banks, it allows them to leverage the underwriting capabilities and last mile reach of NBFCs and helps them fulfill their Priority Sector Lending (PSL) mandates.
These partnerships cultivate a mutually beneficial relationship, fostering increased accessibility, financial inclusivity, and economic growth by fulfilling the financial requirements of the MSME sector. Co-lending partnerships enable the formal lending ecosystem to extend financing support to MSMEs by expanding their reach, reducing risk exposure, and providing affordable credit access. This approach has already seen a huge surge in uptake, with co-lending loans growing from ₹5,000 crores in FY22 to ₹25,000 crores in FY23.
The Way Forward
The role of NBFCs in driving economic growth through MSME financing cannot be overstated. They have demonstrated the ability to bridge the financing gap for MSMEs, and, in doing so, have become instrumental in propelling India’s economic engine forward. The recent edition of TransUnion CIBIL-SIDBI MSME Pulse Report (August 2023) suggests that resilient MSMEs receiving timely credit from lenders are propelling the sector onto a fast-paced growth path. This is evident in the sector’s credit demand, which surged by 33% in the fourth quarter of FY23, with credit demand at NBFCs growing 1.5 times over the previous year, signaling robust growth prospects.
Founder & CEO,
Kinara Capital
However, to fully realize the potential of MSMEs and NBFCs, certain critical actions must be taken, like creating an ecosystem that allows smooth convergence of technology and public policy, like the GSTN on Account Aggregator, which allows lenders to make informed decisions. Stability in the interest rate is another crucial factor. Though there have been no changes recently, any further rise could impact the cost of borrowing and could restrict the ability of NBFCs to support MSMEs effectively. Access to capital for NBFCs is also essential to scaling up MSME lending and the growth of MSME industries.
As the nation charts its growth path, it is imperative to prioritize and nurture this vital sector, ensuring that MSMEs flourish, and in turn, contribute significantly to India’s economic prosperity and resilience.
