Closing the credit gap: Six factors crucial to empowering India's MSMEs

A key and large consumer segment, which traditionally has remained credit-starved, is India’s MSME sector. It is a vital part of our economy, contributing around 30% of the country’s GDP and employing over 100 million people. Easing access to credit for MSMEs is a key cog in the lending industry’s inclusiveness goal.

However, central to the industry’s challenges towards this are the wide under-reporting of income, a large portion of cash transactions and the lack of adequate documentation. To put things in perspective, only around 10% — of the country’s population has access to formal credit, around 5% file their ITRs and even a lesser portion, primarily the self-employed, pay taxes according to their actual income.

As digitisation becomes more real on the ground and the overall lending and financial services ecosystem matures, we can look towards more inclusiveness, with easier access to credit for MSMEs and self-employed consumers of varied scale and demographics. Towards this, six factors would be essential in bringing down the estimated ~ Rs.25 trillion credit gap for MSMEs:

1. Accelerating adoption of Digital Public Infrastructure (DPI) by the industry to ease access: As faster adoption of initiatives like Account Aggregator (AA) grows within the financial services industry, it would enable secure sharing of financial data, providing Banks and NBFCs a clear and succinct picture of an MSMEs financial and credit health, making underwriting more easy, cost-effective and efficient, also leading to better accuracy of offers.

However, what is the need of the hour is a swift movement by the overall industry to adopt the world-class Digital Public Infrastructure (DPI) that has been built. Typically, we have seen the industry to be slightly laggard that often results in 5-7 years before an innovation becomes meaningful on the ground. With the AA ecosystem ready and new initiatives like ULI coming in, the onus is on the industry to move faster in easing access for underserved segments.

2. Govt. push to bring in inclusiveness for MSMEs: The Government, not just through the gold standard Digital Public Infrastructure (DPI), but its various initiatives have also focussed on driving better credit access and financial inclusion for MSMEs. Steps like including bank credit to MSMEs in the ambit of priority sector lending, waiver of collateral security requirements in MSME loans of up to Rs 10 lakh; periodic enhancement in the classification limits of MSMEs; and increase in credit guarantee covers for MSME loans are helping increasing credit access for MSMEs.

The recently announced new credit assessment model based on digital footprints to create automated MSME Loan appraisals should deepen access to credit across the country. The new model will reportedly leverage relevant and verifiable data in the ecosystem, using objective decision-making for both Existing to Bank (ETB) and New to Bank (NTB) MSME borrowers. It is anticipated to be more inclusive than the traditional method of assessing credit eligibility, which relies solely on asset or turnover criteria. It has also been announced that Public Sector Banks, with large consumer bases across Bharat, would also focus on creating stronger capabilities to assess the creditworthiness of MSMEs.

3. GST consistently expanding the umbrella of formal credit: As GST matures into a comprehensive and transparent tax framework for self-employed and small business owners, it would keep opening up new pathways for more MSMEs to access credit. Digital tax records are enhancing financial transparency, facilitating quicker, more cost-effective, and accurate credit assessments. With GST data now supporting cash-flow-based lending, especially as the Account Aggregator framework gains traction, MSMEs can benefit from more tailored credit solutions.

Currently, there are around 1.5 crore GST filers, and as this number grows, the increasing volume of digital financial data will make credit evaluation for MSMEs simpler and more precise, broadening their credit access. As GST and other business-related data integrate further into the financial ecosystem, MSMEs will not only be able to fulfil immediate business needs but also access the larger capital essential for scaling operations and building long-term capacity.

4. Strengthening capital access for new-age NBFCs: Another important factor is capital access for lenders, which continues to be fairly restricted and underdeveloped, especially for new-age NBFCs some of whom have been trying to serve MSMEs. The current situation of moderation of growth around unsecured lending notwithstanding, the long-term opportunity for the emergence of sustainable and cost-efficient underwriting models, powered by rising digitisation and DPI, should help meet the needs of traditionally credit-starved segments like MSMEs. Most of these NBFCs largely depend on Banks for their capital needs, and while it may not be a part of many banks’ strategy to provide this capital, the pool needs to be developed by the industry significantly, for further inflow.

5. Digital play in Collection processes: Post the COVID pandemic, we have seen unprecedented focus by the industry to build digital capabilities. In fact, in the last four years, the lending industry would have leapfrogged close to a decade with respect to the digitisation of processes.

While the industry has done a stellar job in bringing in end-to-end digital processes to ease access to unsecured loans and credit cards, the next step I believe, should be towards making certain parts of the collection process digital. When that starts happening at scale, the cost of reaching out to the customer from a collections perspective will become a fraction of what it is, and things will start becoming more seamless, eventually leading to lower costs and further inclusiveness.

6. A more mature Credit Bureau ecosystem: India’s credit bureau system, though relatively new at around 20-25 years old, has rapidly advanced in the past few years. The combination of quicker reporting, improved data accuracy, and streamlined digital processes has fostered greater awareness of credit health among consumers, including MSMEs, eventually leading to wider access and a more inclusive ecosystem.

The RBI has introduced a key policy change, instructing lenders to report credit information every two weeks instead of monthly from the beginning of this year. This update should significantly reduce the delay in reflecting credit behaviour, cutting down the reporting lag by nearly a month and should help varied segments. Eventually, the reporting would have to move to real-time, enabling a more robust, consumer-focused and efficient ecosystem. This would help better identify over-borrowing, improve risk analysis, and reduce cases of multiple active loans. For MSMEs and other segments, it promises benefits such as more competitive offers and favourable terms, along with a faster response to positive financial behaviour, encouraging better credit management.

(The author is Santosh Agarwal. She is the Chief Executive Officer of Paisabazaar)