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Home >Opinion >Views >We must study the MSME credit gap before we can fix it

In the last decade, significant strides have been made to grant micro, small and medium enterprises (MSMEs) access to credit, but more remains to be done. Globally, it is a complex problem to solve. Given the importance of MSMEs to India’s economy, we cannot take forever to solve it. We need coordinated efforts by stakeholders such as the 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 has been almost two decades in the making, and everything from credit default swaps to interest derivatives were thrown in to achieve it, but with limited impact. To ensure that MSME lending does not go the way of our CBM, efforts must be directed at solving well-identified problems. A ‘hammer looking for a nail’ approach of force-fitting available solutions to misunderstood problems will not work. So that we do not misallocate stakeholders’ resources, let’s first try to size up and understand the MSME-funding problem .

Credit access is better than widely perceived: As per the MSME ministry, India has 63.3 million MSMEs. The upper end has firms with revenues of above 250 crore. The lower end has single-person operators like grocers and everything in between from commercial vehicle owners to village craftsmen. Popular narratives suggest that only 6-10 million MSMEs have formal access to credit, but there is much to suggest that this might be an under-estimate.

Credit bureau records exist for three types of borrowers. First, commercial borrowers that get loans as legal entities (proprietorships, partnerships and private firms). Second, consumers who get individual loans. And third, micro-finance borrowers. By TransUnion Cibil data, there are 9 million unique commercial borrowers. Further, there are an estimated 14-16 million consumers with commercial-vehicle and business loans. These seem to be MSMEs. According to MFIN, there are 58.3 million unique micro-finance borrowers. Industry experts suggest that at least 25% of them are MSMEs. Thus, 34-36 million MSMEs already have access to formal credit.

MSME credit gap: Among MSMEs with credit access, the formalization of their balance sheets would be a major driver of credit growth. While sourcing bank loans, many MSMEs also borrow from informal sources for their ‘cash’ transactions. Formal accounts only have transactions captured by goods-and-services-tax data systems. Greater formalization could see MSME demand for formal credit jump by 30-50% (i.e., by 8-15 trillion), though this will have to be largely driven by a regulatory push and the intent of borrowers to avail formal loans.

India’s 27-29 million MSMEs without any access to formal credit form the long tail of MSME credit demand. Such borrowers may be expected to have, at best, the debt capacity of an average micro-finance borrower , which is about 30,000. This translates to credit demand of no more than 1 trillion. Recall that borrower intent is a major driver of closing the estimated credit gap of 8-15 trillion.

New-to-credit (NTC) MSMEs: The problem they face is longer timelines for loan approval more than outright rejection. According to a report published by TransUnion Cibil, India adds 0.6-0.8 million NTC commercial borrowers each year. Even for products such as business loans (usually unsecured), an estimated 20-25% are NTC who get credit on the basis of tax return documents and bank statements. Large lenders as well as some fintech firms with proven techno-analytical abilities to use this data, plus alternate data, to underwrite loans. To the extent that lenders have to consider fraud and credit risk, field investigations are a critical aspect. The efficiency in offering loans to new borrowers depends on the lender’s level of sophistication.

Some need to renew focus, while others need to refocus and recalibrate: Available credit and know-your-customer information is leveraged by avante-garde lenders to digitize the process of lending to MSMEs. Thus, the speed of approvals and quality of decisions are driven by their investment in digital systems.

While the available credit data infrastructure can surely be enhanced, its current state is not a constraint in itself. However, the range of MSME loan products needs to widen. Loan products of tenures less than 3-6 months are usually unavailable to them, for example. MSMEs need a wider set of credit options. Small businesses also tend to lack collateral to put up for loans. Leading Indian non-banking finance companies have been successful in unsecured business lending. However, for banks to move en bloc towards unsecured business lending would require greater regulatory encouragement.

Public-private partnerships (PPPs) may be required to provide credit access to the 27-29 million MSMEs that lack access. We could try the following. Digitalization may enhance operational efficiency, reducing the acquisition cost of small-ticket borrowers while charging them lower interest rates. Micro-finance lenders are possibly well placed to serve the MSME sector, but for efficiency to kick in, they would have to employ top-notch technology to improve their analytical capacities. Perhaps a PPP model can be devised that uses a common ‘credit stack’ equipped with advanced artificial intelligence to offer loans to unserved MSMEs. To provide credit access to tail-end MSMEs, we need a lot more than just a super-app.

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