A positive effect has been seen in lending to India’s previously underdeveloped micro, small, and medium-sized companies (MSMEs), thanks to the pandemic’s global shift toward a largely digital future. Technology, alternative data sources for building credit profiles, and receivable financing models as a replacement for collateral-backed lending have all contributed to the doubling of lending to MSMEs over the past two years. To make sure MSMEs continue to make a significant contribution to India’s economic progress, however, growth alone won’t be enough, like everything else in this new world. It must be underpinned by resilience and sustainability.
Recent statistics (MSMS Pulse August 2022, TransUnion CIBIL, and SIDBI) show that loans made to MSMEs more than quadrupled to over INR 3.25 lakh crore in Q4 2021–22 as compared to INR 1.58 lakh crore in Q4 2019–20. NPAs also increased along with this expansion; in Q4 FY22, MSME NPAs for Public Sector Banks (PSBs) was high at 20.8% and for Non-Banking Finance Companies (NBFCs) at 9.6% (compared to 17.8% and 8.2%, respectively, in FY Q420). MSME NPAs persisted in their high 5%-7% range even at private banks.
We would surely not want to enter a negative cycle where lenders cut their exposure to MSMEs, therefore limiting their chances for development. A recent legislative assessment indicated a credit gap for MSMEs of close to INR 20–25 trillion, despite the fact that 90% of all Indian businesses are thought to fall into the MSME category. This shows how important MSMEs are to the economy and how much financing they offer.
How can we prevent the MSME journey from being cut short owing to a lack of funding? We believe actions to promote resilience and sustainability, including increased digitalization, borrower education, broader policy support, and sound lending standards, may make a big difference.
Digitization Is On The Rise
Lenders may now assess borrowers’ capacity to repay loans more accurately because of the availability of high-quality data, such as that provided by GST filings. However, additional data on MSMEs’ activities would provide lenders with a complete picture of how their money is being used. In order to benefit from GST and performance data that is represented in banking accounts, borrowers must automate their accounting systems. Lenders would be more likely to open their wallets if MSMEs adopted the accounting and business management systems that are being offered at incredibly low prices. Lenders will be able to assess borrowers’ loan worthiness and increase the number of borrowers they may lend money to with a better understanding of how they do their daily business (i.e. extend formal credit to new MSME customers)
The Education System
While digitalization, such as the widespread use of UPI to replace cash as a form of payment, is altering people’s lives, it may also alter their companies. A strong policy-mandated environment for investor education has contributed significantly to the financialization of savings, the formalization of payment methods, and the expansion of retail investment in the nation. Similar frameworks for awareness programs and campaigns among MSME borrowers would aid in fostering good borrowing practices, improving their capacity to choose the best source of funding, such as equity, short- or long-term debt, understanding how lending cycles work and, consequently, better preparing them to take on and service more financing, and accelerating their growth journeys.
Habits Of Lending
While the environment must be improved through borrower education, possibly harmful behaviors that are encroaching on digital/NBFC lending must also be stopped. Additional/multiple loans are given to the same borrowers in a haste to ensure faster disbursements and fulfill objectives, which causes over-leveraging and raises the risk of them becoming non-performing. Such a technique is only discovered after it is too late because the credit bureaus are not updated in real-time.
Providing Policy Support
Credit flow into the industry is already being facilitated by programs like the Credit Guarantee Fund Trust for Micro and Small Enterprises. More of these support systems would make it easier for lenders to evaluate MSMEs and increase credit flow to the industry. In order to facilitate working relationships between fintech, NBFC, and banking companies and enable digital lending to MSMEs, policymakers should also think about relaxing rules.
To further strengthen the MSME financing environment, other crucial actions include accelerating the resolution of delayed MSME assets through particular ARC and bankruptcy resolution methods. Another strategy for assuring increased cash flow and balance sheet accessibility for MSME lenders may be to create liquidity through the trading of MSME loans and bonds.
While there has been a lot of regulation for lenders, policymakers should think about taking comparable action against borrowers who willfully default. In general, borrowers obtaining many unsecured loans are aware that defaulting on the obligations would have little impact because the unsecured lenders will only have long legal battles as a last resort.
At the moment, the only way for unsecured lenders to obtain justice is to use Section 138 of the Negotiable Instruments Act (cheque bouncing). However, given the overwhelming backlog of more than 33.3 lac Section 138 cases in the courts, it is no longer a reliable deterrent. The authorities must take into account a quick resolution or quick settlement process for unsecured situations.
Nearly 40% of the workforce, nearly half of India’s exports, and approximately a third of its GDP are all served by the MSME sector. India is actively moving toward being a hub for global manufacturing as a result of the altered political and corporate climate throughout the world. This will enable India to achieve its own goals of greater economic growth and job creation for its burgeoning population. The lessons acquired from the Indian MSME experience might help the rest of the globe and other developing markets as India plays a bigger role in the G20. Countries looking to improve the lives and livelihoods of their populations would benefit most from this.
All of these objectives would be greatly aided by a thriving and competitive MSME sector in India. MSMEs will strengthen and expand more quickly when there is a strong financing system in place and a big number of lenders. Fintech, innovation, and technology are already working together to energize the MSME loan market. Some of the aforementioned gradual efforts will give this dynamic more robustness. At a recent conference, RBI Governor Shaktikanta Das said, “We have learned a lot on these factors; we need to leverage much more.”