India has approximately 630 Lakh MSME companies out of which only 250 Lakh have ever been credited. While the sector continues to grow at a projected compound annual growth rate (CAGR) of 2.5 percent, in the coming times, the approximate number of MSME corporate entities is expected to touch 750 Lakh. Out of this estimate, about 500 Lakh are expected to be NTC (New-to-Credit) MSME units, highlighted a recent joint report by TransUnion CIBIL and SIDBI.
With a 30 percent share of the economy’s GDP and a 45 percent share of total employment, MSMEs are the growth engines of the Indian economy. MSME loans are a major component of business loan market contributing about 85 percent by volume as of March 2021.
However, despite its importance in shaping the socio-economic development of the country, MSMEs face a major challenge in obtaining sufficient financing, with an estimated credit gap of Rs 33 trillion. According to an IFC report, formal credit provision addresses only USD 165 billion (Rs 10.9 trillion) worth of MSME financing needs. The overall financing requirement of MSMEs is 69.3 trillion rupees, with 70 percent of the credit requirement attributed to filling capital shortfalls.
MSMEs borrow from informal sources to finance their needs due to lack of documentation or credit. Credit access can help unorganized MSMEs integrate into the formal economy, compete with global players, and gradually transition into the organized, formal sector.
The overall financing requirement of MSMEs is 69.3 trillion rupees, with 70 percent of the credit requirement attributed to filling working capital gaps. Working capital finance is an important aspect for the budding MSME business. It is imperative to address huge credit gap that exists to meet urgent requirements. There are no MSME-focused sachet products. Lenders rely heavily on assets earmarked against express loans, leaving MSMEs out of bagged loans for working capital gaps, a latest report by 1Lattice has revealed.
MSME working capital loans act as a ‘cushion’ to help with short-term cash issues. One of the main reasons for obtaining a working capital loan is to obtain funds during periods of low demand in the business cycle. Structured and intuitive capital management allows MSMEs to seize new business opportunities and acts as a lifeline in turbulent and unforeseen times.
MSMEs are important yet overlooked drivers of the national economy. Various factors such as complexity of MSME finance, unavailability of credit, regulatory issues, low scalability, labor issues, and absence of standardized policies have contributed to the problem.
The total Indian loan outstanding market stands at approximately 174 trillion rupees and has grown by around 100 percent between FY17 and FY22. Retail and Business loans each account for about 49.5 percent of the total loan market as of March’22, the 1Lattice report highlighted.
MSME segment witnessed an increase in the origination share in terms of value of about 38 percent in FY22 as compared to 27 percent in FY21 under commercial loans. The total volume of originations stands at 22.2 lakh in FY22 of which 87.9 percent (19.5 lakh) is accounted for by the MSME borrower segment. The total value of originations is Rs 66.6 trillion in FY22 of which 38.1 percent (Rs 25.3 trillion) is accounted for by the MSME borrowers segment, the report further stated.
Micro borrower segment continues to dominate originations (by volume). However, there is a decrease in share from 53.7% in FY21 to 46.1% in FY22. Despite a decline in the volume of the Micro segment in FY22, the value share of this segment increased from 4.7 percent in FY21 to 12.4 percent in FY22.
There has been an increase in origination share (by value) of MSMEs from 27.2 percent in FY21 to 38.1 percent in FY22. Originations by value were dominated by the large corporate during FY19-FY22. However, the share declined from 73.6% in FY19 to 56.3% in FY22, the report added.
FinTechs and NBFCs help solve creditworthiness of MSMEs
Traditional lenders require MSME borrowers to provide credit history, formal records, business vintage, etc., which excludes many small businesses from the formal lending ecosystem. Heavy reliance on previous credit history and lack of understanding of digital loan solutions cause difficulty in assessing the creditworthiness of MSMEs.
Fintech and NBFCs are revolutionizing the MSME lending space and helping to resolve creditworthiness issues between banks using alternate data processing and technology. New era/ Fintech players risked modeling the SMEs by creating credit scores (for those who lack previous credit history) so that NTC clients can get loans, the 1Lattice report highlighted.
Fintech and NBFCs can help banks overcome information asymmetry on MSMEs. In India, the unsecured NBFC and fintech lending landscape has emerged, with several new players only catering to the MSME segment. NBFCs and FinTechs leverage their distribution strength and superior customer underwriting with banks that have cheaper capital and better risk management processes.
The way forward for MSMEs in India
Untapped potential of MSMEs could be developed with the government induced policies and new age Fintech players. The Indian government intends to increase annual MSME financing disbursements to about Rs 6 lakh crore by 2023. Banks have approved loans worth Rs 3.1 lakh crore under the ECLGS for the MSME sector.
The majority of the credit deficit will have to be filled through structural, market-driven solutions. As a result, fintechs/new-age players are using technology to eliminate market inefficiencies, making lending more accessible, affordable and contextual for MSMEs, the 1Lattice report said.
The change brought about by digital lending is changing the optics of MSME lending. What was once an arduous and time consuming task becomes an easily accessible business decision with the synergy of new age players, banks and government regulations.
Unsecured MSME lending in India is expected to reach Rs 7.5 trillion by FY26 with digital lending channel expected to grow at approximately 29 percent CAGR. MSME business base is expected to rise to 14 million in FY26. Digital penetration in unsecured MSME lending is expected to increase to around 20 per cent in FY26, the report added.
Due to the rapid adoption of digital technologies by MSMEs and the accelerated digital connectivity of the country, the digital presence will gradually increase and should reach 20 percent by FY26.