Photo: Mint
Photo: Mint

Are  MSMEs adding to our NPA woes?

Bad loans to micro, small and medium enterprises have risen recently, but the sector’s access to credit may be a bigger issue, suggests data

India’s ailing banking sector could be facing another problem: non-performing assets (NPAs) in the micro, small and medium enterprises (MSME) sector. Last week, deputy governor of the Reserve Bank of India (RBI) M.K. Jain, raised concerns about the rise of NPAs in Mudra loans, the government’s flagship small loans programme. These concerns echo the points made by the U.K. Sinha-led expert committee on the MSME sector in its July 2019 report.

In India, MSMEs, which include all firms with physical capital valued at less than 10 crore, employ millions and are considered an engine of growth. But this engine is now sputtering. Several forces, such as GST and demonetization, have constrained MSME growth but an overarching factor has been a severe liquidity crunch.

Credit exposure to MSMEs increased by 12% to 15.7 trillion in June 2019 (from 14 trillion in June 2018), according to data from TransUnion CIBIL, a credit information company, and Small Industries Development Bank of India (Sidbi). But this still falls significantly short of the total credit requirement in the sector. According to a 2018 study, the MSME sector has a credit gap of around 26 trillion with 90% of this gap felt by micro and small enterprises. And as a share of total bank credit extended in the economy, credit to MSMEs has dried up. In March 2010, 17.3% of total bank credit was deployed to MSMEs but in March 2019 this had shrunk to 13.6%. To make up for the shortfall, MSMEs resort to informal channels of credit which come with a significantly higher cost of capital.


The MSME sector may also be becoming vulnerable to the NPA issue that has stricken the Indian economy. According to data from TransUnion CIBIL, NPA rates across the MSME sector spiked in the quarter ending June 2019. Among firms with credit exposure of less than a crore, the NPA rate jumped to 8.7% from 8.1% in the previous quarter.

The NPA problem, though, increases with the size of the loan disbursed. Firms in the bigger credit exposure segment (exceeding 25 crore) have NPA rates of around 18%.


Though private sector banks and non-banking financial companies (NBFCs) increasingly account for a greater share of the credit to MSMEs, the biggest formal credit source for MSMEs remain public sector banks (PSBs). As of June 2019, nearly half of all credit disbursed to MSMEs came from PSBs and these are the banks most vulnerable to MSME-related NPAs. In the June 2019 quarter, 16% of all PSB MSME credit was NPAs (up from 14.5% in the same quarter in June 2017) nearly three times the rates in private banks and NBFCs.


Within MSMEs, some industries are suffering more. According to the TransUnion CIBIL report, the textile sector and the construction sector have the highest MSMEs NPA rates, while the auto industry is relatively less affected.

The biggest reason why MSMEs can be more vulnerable to NPAs is the nature of their work. Most small enterprises, both formal and informal, are embedded in supply chains where they supply their products and services to larger firms. Consequently, these smaller firms constrained by their weaker bargaining power become dependent on larger firms.

This can mean delayed payments from larger firms, constrained liquidity and greater difficulty in repaying loans. According to the U.K. Sinha report, this explains around 41% of all stressed loans in the MSME sector. Other business-related factors also make MSME credit vulnerable to NPAs.

Small firms, for instance, find it more difficult to withstand a sudden change in competition or regulation.


The same factors that make MSME credit vulnerable to NPAs are contributing to the overall MSME liquidity crunch. Banks are wary of the risks associated with MSMEs and hence reluctant to lend. Assessing the credit-worthiness of MSMEs can also be difficult, especially in the absence of financial details. The Indian government is trying to address these issues. In 2017, it launched the Trade Receivables Discounting System, an exchange designed to expedite payments to MSMEs. On access to credit, banks have constantly been directed to lend to MSMEs as part of the RBI’s priority sector lending requirements.

But the U.K. Sinha Committee has suggested more needs to be done. To ease the liquidity crunch, the committee has recommended establishing a 10,000 crore “fund of funds" to support private equity and venture capital investment into MSMEs. And to stem NPAs, the report suggested establishing 5,000 crore stress fund, which would work in tandem with bank-led NPA revival plans, to help MSMEs.

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