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Risk-averse banks’ negative impact on MSMEs

The Prime Minister's dream of a $5-trillion Indian economy by 2025 along with effective financial inclusion and sustainable economic outcomes is premised on investment from both domestic and foreign investors. Government expenditure can only provide a stimulus, but cannot alone take India to PM's goal.

For domestic private investments to happen, the role of timely, adequate and quality (low cost) credit cannot be overstated, particularly during the current times when Covid induced stress is maximum on almost all industries. With the recent change in the definition, more than 95 per cent of Indian companies are bought under the definition of MSMEs.

So what ails the MSME sector largely reflects the credit eco-system for more or less the entire industry in this country. The large corporate and top business houses have had any difficulty in accessing credit.)


Most of the MSMEs are in rural and semi-urban areas where access to credit is extremely limited. They are vulnerable to predatory moneylenders and often fall into a cycle of debt. Lack of access to finance and timely credit support in business has been a long-standing issue for these MSMEs.

Starting from difficulties faced in seeking loans and working capital from banks to delay in receiving government payments and tax refunds, most of the MSMEs are under severe debt.

As per an IFC study, there is an overall debt demand of ₹69.3 trillion of which 84 per cent is financed by informal sources such as moneylenders, family, friends, chit funds. Formal sources such as commercial banks, NBFCs and government institutions cater to a mere 16 per cent.

Out of these Rs. 10.9 trillion, Rs. 8.8 trillion is supplied by commercial banks while Rs. 1.5 trillion by NBFCs. The failure of traditional lending mechanisms to guide credit towards these MSMEs have led to a scenario where financing is often not reliable, and steady.

This has been particularly exacerbated by the pandemic, as well as the poor state of microfinancing in the country, highlighted by India's estimated credit gap of over $330 billion.

Further, when more these 80 per cent of these MSMEs are in the micro and small category and depending on informal sources of credit, the usefulness of the government's emergency line credit, stressed asset relief, equity participation and fund of funds operation make very little meaning and contribution to the sector.

Banks employ various methods to limit risk by better assessment of the creditworthiness of individuals or firms, MSMEs included. To keep NPAS down, many creditworthy individuals are denied loans by banks.

Another issue is the lack of paperwork or digital footprint for small MSMEs, a factor that holds them back from being integrated into the formal economy and deprives the MSMEs to take advantage of the formal credit system.

They continue to gain access to credit against assets such as land, etc. when much of the MSME development has started to follow a digital model.

Recording transactional details such as utility payments, electricity bills, etc. would give insight into the financial behaviour of these entities that can aid in extending credit coverage to the unserved/underserved MSMEs.

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