Micro, Small and Medium Enterprises (MSMEs) are strategic assets for economic development and employment generation, but remain too small and informal to make an impact. Over 95% of Indian enterprises are classified as micro, leading to the curious ‘missing middle’ syndrome. One of the key factors inhibiting the scaling up of MSMEs is a lack of affordable finance. MSMEs face a credit gap of ₹69.3 trillion out of which only ₹36.7 trillion is addressable by formal financing.
Demand and Supply FInancing Constraints
Both demand and supply constraints result in lack of financial inclusion of MSMEs. Demand-level constraints in the MSME ecosystem include delayed payments from buyers, inadequate formal records, and information asymmetry among MSMEs. Limited supply of formal financing by banks due to outdated underwriting process, unsuitable loan products and high transaction cost prohibit MSMEs from accessing credit at affordable rates.
Multiple stakeholders are providing a range of financing options to MSMEs. Banks, non-banking financial companies (NBFCs) and microfinance institutions remain the main institutional credit providers. Digital lending through financial technology companies, or fintechs, is solving unique and sector-specific challenges. Through their platforms such as TReDS, government and regulatory bodies are enabling invoice discounting to address working capital needs of MSMEs.
Recommendations for Action
Despite interventions by ecosystem stakeholders, common challenges persist. To solve these challenges, three critical levers should be addressed:
- Solving for delayed payments, which requires greater uptake of TReDS and capacity-building of MSMEs
- Banks and NBFCs need to increase their lending to MSMEs by revamping their credit appraisal process and innovating loan products for MSMEs and
- Scaling up digital lending is necessary for financial inclusion of micro and small enterprises by building trust in digital products through a phygital (physical+digital) approach.
Authors: Prerit Shukla with support from Deshna Saraogi