MSME funding in India: The government plans to establish a separate bank to directly lend to micro, small, and medium enterprises. The industry has called for an increase in credit flows to this under-penetrated sector. Currently, institutions like SIDBI primarily refinance loans rather than lend directly. However, state financial corporations and state industrial development corporations do lend directly to MSME units.
There is a need to boost the MSME sector in the country. According to an EY report, MSME credit penetration is only 14% in India, which is dismal compared with larger economies such as the US and China, where credit penetration stands at 50% and 37%, respectively. Indian MSMEs face a significant credit shortage of Rs 25 trillion, highlighting a large untapped credit market. Increased lending to MSMEs will benefit the economy by boosting economic activity and job creation.
READ | Govt plans income tax revamp to offer relief for middle class
A specialised bank for MSME lending?
A separate bank dedicated to the MSME sector would address direct credit shortages, and this proposal is under consideration. Before a decision is made, the government needs to work out details such as the bank’s ownership structure, which might include a hybrid (public-private partnership) model. While large banks exist, they often fail to grasp the specific needs of MSMEs. Lessons can be taken from some European countries where MSMEs are grouped with home loan customers, as both are small borrowers.
If the government is unable to establish a separate bank, SIDBI should be converted into a full-fledged bank for direct lending to MSMEs, rather than focusing solely on refinancing. SIDBI is a key player in financing India’s MSMEs and is owned by a consortium including the government and major financial institutions.
With access to low-cost funds, SIDBI helps banks meet their lending quotas for MSMEs under priority sector lending targets. In the latest financial year, SIDBI allocated Rs 84,000 crore for refinancing loans to micro and small enterprises. However, SIDBI’s future growth depends on how well commercial banks fulfil their PSL targets. A report by ICRA warns that if banks meet their quotas more effectively, there might be less need for SIDBI’s refinancing role.
Challenges to MSME funding
While MSMEs form an important part of the country’s economy, access to adequate, timely, and low-cost finance poses a significant hurdle to the sector’s growth prospects. However, the outstanding credit to MSMEs by scheduled commercial banks expanded by 20.9% annually to Rs 26 trillion at the end of December 2023. Limited credit history, insufficient collateral, lack of knowledge about government support, and high borrowing costs make it tough for MSMEs to access funding. Unlike large companies, MSMEs do not have an established track record and thus find it difficult to secure loans from banks and other financial institutions. Investors are deterred by the risk factor.
In India, there are 64 million MSMEs, and 99% of them are micro-enterprises. Despite global adversities, the sector has cushioned the economy from shocks. In a country with a wide gulf between urban and rural areas, the sector helps uplift less developed areas, reducing regional imbalances and inequality. The sector also provides over 110 million jobs or 23% of the country’s labour force, making it the second-largest employer in India after agriculture.
The importance of MSMEs to the Indian economy cannot be overstated. They drive innovation, generate employment, and contribute significantly to exports and GDP. By fostering entrepreneurship and supporting large-scale industrialisation, MSMEs play a pivotal role in reducing regional imbalances, uplifting economically weaker sections, and stimulating socio-economic development. Their adaptability and resilience make them indispensable in the face of economic adversities, ensuring the continuous dynamism of the Indian economy. With a contribution of 27% to India’s GDP, 38.4% of total manufacturing output, and 45% of the country’s total exports, the sector is the backbone of the economy.
Global models to emulate
To address the sector’s challenges, interventions are needed for providing loans at the same interest rate as housing, i.e., 6% for exports and 8% for regular domestic production activities. Currently, the bank interest rate for MSMEs is 11-13%, and for exports, 8-9%. In an increasingly digital world, MSMEs need to embrace digital financing. Beyond funds, digital financing will also provide valuable data-driven insights to help MSMEs make smarter business choices.
The government has launched several initiatives to promote MSME financing, such as the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), Pradhan Mantri Mudra Yojana (PMMY), and Stand-Up India. While these efforts are laudable, the government must also ensure that there is awareness of these schemes so that more enterprises can benefit. The private sector must also step up to promote MSME financing. Without public-private partnerships, alliances, and collaborations, SME financing will continue to remain a challenge.
In the United States, MSMEs have access to funding through a variety of federal and state programs. The Small Business Administration (SBA) plays a crucial role by offering loan guarantees that encourage banks and other financial institutions to lend to small businesses. Programs like the 7(a) Loan Program, the 504 Loan Program, and the Microloan Program provide capital for different business needs, including working capital, equipment purchases, and real estate acquisitions. Additionally, the U.S. government supports MSMEs through grants, venture capital initiatives, and state-specific funding programs that cater to local business environments. The diverse range of financial products and support mechanisms ensures that MSMEs can find suitable funding options for their specific requirements.
In the European Union, MSMEs benefit from a robust framework of financial support facilitated by institutions such as the European Investment Bank (EIB) and the European Investment Fund (EIF). These entities provide funding through intermediaries like banks and microfinance institutions, offering loans, guarantees, and equity financing. The EU also promotes MSME funding through programs like COSME (Competitiveness of Enterprises and Small and Medium-sized Enterprises) and Horizon 2020, which focus on innovation and competitiveness.
In China, the government has implemented various measures to enhance MSME access to finance, including policy banks like the China Development Bank providing targeted lending, and local governments setting up credit guarantee funds. Additionally, China’s financial technology sector has seen significant growth, with online lending platforms and digital financial services providing alternative funding sources for MSMEs. These comprehensive approaches in the US, EU, and China serve as models for how India can enhance its own MSME financing landscape. There is still a long way to go to ensure that all MSMEs have access to affordable and timely financing.