Financial Institutions Turning Towards MSME Lending

• MSME sector is estimated to grow at 15%-17% this year.
• Almost every type and size of industry took a hit during the pandemic; MSMEs, however, were affected the most.
• A recent report by RBI pegged the credit gap in the segment to be a staggering INR 20-25 trillion.

Today Micro, Small, and Medium Enterprises (MSME) sector contribute over 27% ( more than INR 39 trillion ) of India's GDP making them vital to our nation's economy. This is further estimated to grow at 15%-17% this year. With more than 60 million MSMEs in the country, accounting for significant formal and informal employment, they have been an essential source for innovation and job creation.

Almost every type and size of industry took a hit during the pandemic; MSMEs, however, were affected the most because they lacked the necessary and sufficient resources to remain steady during the most challenging times. The competition with the larger firms has also stiffened due to the time it is taking to recover.

Touted as the economic growth drivers, MSMEs do have access to formal credit, but there remains a gap in how effective it is.

With credit demand now exceeding the pre-pandemic levels, the need for a robust ecosystem to fill the gap is of prime importance. Additionally, with the government impetus and focus on the segment, there is no doubt that this is a problem worth solving.

Alongside the government support, private sector financing options for MSMEs can come from Equity financing, Debt financing or venture capital debt. Given the holding structures of most MSMEs, the preference remains for debt financing and here is where the Financial Institutions ought to play the most crucial role.

That said, this segment's distinct characteristics have hindered lending Institutions from fully capitalizing on the opportunity. Most businesses are seasonal and have uneven cashflows, making income assessment a challenge which is a key parameter for credit appraisal. A fast-changing competitive landscape can outpace the segment, adding to the risk for the lenders.

Traditionally, the loans have always been repaid in equal monthly instalments. Offerings that allow flexibility for bespoke, start-low, quarterly repayments etc. will complement the borrower's seasonality and uneven cash flow problem and still allow room for business growth. Quicker data-driven decisions, nuanced income assessments, and digital delivery of lending products will address the credit gap in a much more personalized manner.

Given their significance to the GDP, MSMEs can make use of a more efficient credit ecosystem. With green shoots of economy visible, the time is opportune for lending institutions to rejuvenate the sluggish monetary ecosystem of MSMEs.