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Manish Khera

Manish Khera, Founder & CEO, Happy, one of India's most innovative loan facilitators.

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How RBI Regulatory Support Can Strengthen MSME Lending

According to the ICRA, India’s MSMEs were suffering a mind-boggling shortfall of INR 25 trillion, and were suffering from historic lows in terms of credit disbursal.

India’s MSME sector is a study on contrasts. On the one hand, this sector is the powerhouse of the Indian economy, contributing almost 38% of India’s GDP, employing over 110 million people, and accounts for 45% of India’s manufacturing output, and 40% of its gross exports. However, for all its potential and its importance for the Indian economy, MSMEs in this country are being starved of the capital they need to grow.

According to the ICRA, India’s MSMEs were suffering a mind-boggling shortfall of INR 25 trillion, and were suffering from historic lows in terms of credit disbursal. The current credit shortfall can be ascribed to a variety of factors – GST, demonetisation, the rash of NPAs in PSU banks, but India’s MSMEs have a long history of being systematically financially excluded even otherwise. At present, a massive 67% of all outstanding commercial credit was provided by Indian banks to large corporates, even though these loans exhibit a delinquency of 18% - substantially higher than the 11.2% delinquency rate for MSMEs.

The underlying problem in lending to the MSME sector

If there is a higher demand for credit, as well as a better track record of repayment, why are banks continuing to focus on lending to large corporates? The reasons for this discrepancy are more clearly understood when one studies the legacy banking and financial sector in India. India’s legacy BFSI lenders are highly regulated, and the documentary requirements to avail a loan from a bank in India are quite exhaustive. Further, institutional lenders have to look at a credit score provided by an accredited bureau to determine the creditworthiness of a loan applicant. To generate a credit score, the bureaus require MSMEs to have a comprehensive transactional record. As most of these small units are largely run on cash payments, this transactional history doesn’t exist for most MSMEs in the country.

The ray of sunshine in this dour picture is that new age startups are looking to disrupt this space. By utilizing AI-driven algorithms and collecting all manner of transactional data across multiple touchpoints, these companies are doing away with any need for banking and transactional history. Further, thanks to the deployment of Aadhaar-based KYC systems, the need for documentation and long waiting periods is done away with. The impact of these NBFC lenders has helped drive an increase in credit to this sector, leading to researchers at Dun & Bradstreet and Transunion CIBIL-SIDBI claiming that India’s MSMEs have managed to move past the impact of demonetisation and GST.

The role of the RBI

There is no doubt that the RBI is, at present, doing various different things to encourage lending to MSMEs. First, it has temporarily allowed small businesses to delay their repayments up to 180 days from the due date without being classified as a bad loan. The Government also announced that it would double the credit guarantees under the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), set up by the MSME Ministry. However, much of the refinancing effort of the government has been mobilized through the Micro Units Development Refinance Agency (MUDRA). At an event organised by the Indian Merchant Chamber, RBI Chief General Manager P. Vijaya Kumar asked NBFCs to lend more to MSMEs. 

There’s good reason for them to do so, as well – MSMEs in China, for example, are responsible for over 80% of job creation and 70% of technological innovation. For India to use this sector to power its economy and hit the USD 5 trillion mark by 2025, it must do something about the fact that out of the 63.3 million MSMEs in the country, less than 5 million have access to formal credit. This regrettable scenario can be drastically improved if the RBI would classify MSME loans from NBFCs as Priority Sector Lending (PSL).

Before April 2011, banks were allowed to reach their lending targets to priority sectors as mandated by the RBI by refinancing NBFCs that were catering to MSMEs. However, the RBI made this refinancing ineligible for priority sector classification. This has led to a paucity of funds for NBFCs to disburse. Given the small ticket size, longer tenures, and higher expense involved in reaching out to MSMEs, banks have been of little or no help directly. However, their deep pockets can be used to act as fuel for NBFCs with systematic and technologically advanced processes. Increasing avenues of cash flows to MSMEs by placing NBFC refinancing as eligible for PSL quotas would go a long way in reducing financial exclusion and improving economic productivity.

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house

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