Over the past decade, significant progress has been made in providing access to credit to micro, small and medium enterprises (MSMEs), but much remains to be done. Overall, it is a complex problem to solve. Given the importance of MSMEs to the Indian economy, we cannot take forever to resolve it. We need coordinated efforts from stakeholders such as government, lenders, credit bureaus, fintech players and various voluntary groups. There is a cautionary tale in India’s efforts to develop a corporate bond market (CBM). It took almost two decades to do this, and everything from credit default swaps to interest derivatives has been implemented to make it happen, but with limited impact. To ensure that loans to MSMEs do not follow the path of our CBM, efforts must be directed towards solving well-identified problems. A ‘hammer-in-the-nail’ approach to available force adjustment solutions to poorly understood problems will not work. In order not to misallocate the resources of stakeholders, let us first try to measure and understand the problem of financing MSMEs.
Access to credit is better than most people think: According to the Ministry of MSMEs, India has 63.3 million MSMEs. The top end has businesses with revenues greater than ₹250 crore. The lower end has one-person operators like the grocers and everything from utility vehicle owners to village artisans. Popular accounts suggest that only 6-10 million MSMEs have formal access to credit, but there is much to suggest that this could be an underestimate.
Credit bureau records exist for three types of borrowers. First, commercial borrowers who obtain loans as legal entities (sole proprietorships, partnerships and private companies). Second, consumers who get individual loans. And third, microfinance borrowers. According to data from TransUnion Cibil, there are 9 million unique business borrowers. In addition, it is estimated that 14 to 16 million consumers have loans for utility and commercial vehicles. These appear to be MSMEs. According to MFIN, there are 58.3 million unique microfinance borrowers. Industry experts suggest that at least 25% of them are MSMEs. Thus, 34 to 36 million MSMEs already have access to formal credit.
MSME credit gap: Among MSMEs with access to credit, the formalization of their balance sheet would be a major driver of credit growth. While obtaining bank loans, many MSMEs also borrow from informal sources for their “cash†transactions. Official accounts only contain transactions entered by the Goods and Services Tax data systems. Further formalization could lead to a surge in demand for formal credit from MSMEs of 30-50% (i.e. ₹8-15 trillion), although this will need to be driven largely by regulatory push and borrowers’ intention to qualify for formal loans.
India’s 27-29 million MSMEs without any access to formal credit form the long tail of MSME credit demand. These borrowers can be expected to have, at best, the debt capacity of an average microfinance borrower, which is about ₹30,000. This translates into a request for credit of no more than ₹1 trillion. Recall that the borrower’s intention is a major driver in closing the estimated credit gap of ₹8 to 15 billion.
Newly credited MSMEs (NTC): The problem they face is more loan approval times longer than outright rejection. According to a report released by TransUnion Cibil, India adds 0.6 to 0.8 million NTC commercial borrowers each year. Even for products such as business loans (usually unsecured), it is estimated that 20-25% are NTCs who obtain credit on the basis of tax return documents and bank statements. Large lenders as well as some financial technology companies with proven techno-analytical capabilities to use this data, as well as other data, to take out loans. As lenders must consider fraud and credit risk, field investigations are critical. The effectiveness of offering loans to new borrowers depends on the level of sophistication of the lender.
Some need to renew their focus, while others need to refocus and recalibrate: Available credit and know-your-customer information is leveraged by forward-thinking lenders to digitize the MSME lending process. Thus, the speed of approvals and the quality of decisions are dictated by their investment in digital systems.
While the available credit data infrastructure can certainly be improved, its current state is not in itself a constraint. However, the range of MSME loan products needs to expand. Loan products with a term of less than 3 to 6 months are generally not available to them, for example. MSMEs need a wider range of credit options. Small businesses also tend to run out of collateral to obtain loans. Major Indian non-bank financial companies have been successful in securing unsecured business loans. However, for banks to move towards unsecured corporate lending as a whole, more regulatory encouragement is needed.
Public-private partnerships (PPP) may be needed to provide access to credit to the 27-29 million MSMEs who do not have it. We could try the following. Digitization can improve operational efficiency, lower the acquisition cost of small borrowers while charging them lower interest rates. Microfinance lenders may be well positioned to serve the MSME sector, but to be effective they should use cutting edge technology to improve their analytical capabilities. Perhaps a PPP model can be designed that uses a common “credit stack†equipped with advanced artificial intelligence to deliver loans to unserved MSMEs. To provide access to credit to final MSMEs, we need more than just a super-application.
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