MSME

India's Mammoth Priority of Classifying Non-Banking Financial Loans to the MSME Sect

While NBFCs have come to the rescue of credit-starved MSMEs, classifying these loans under priority sector lending still a distant dream
India's Mammoth Priority of Classifying Non-Banking Financial Loans to the MSME Sect
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Guest Writer
Founder & CEO, Power2SME
6 min read
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For developing countries across the globe, access to proper financial resources to support flourishing businesses is imperative to infuse growth into their economies. In India, the MSME sector, over the years, has become the backbone of the Indian economy, playing an instrumental role in the development of the country. While the government has taken proactive measures to usher in a revolution that promises banking services to the unbanked, certain sectors in the economy are still deprived of their right to receive robust financial support. Though the NBFCs have come to the rescue of credit-starved MSMEs, classifying these loans to the sector under priority sector lending (PSL) still remains a distant dream.  

The underlying potential of the MSME sector

The MSME sector has played an instrumental role in India’s growth story however, it still remains largely unorganised. As per the Ministry of MSME’s Annual Report, there are 63.3 million MSMEs in the country contributing 45% of Industrial production and 40% of country’s exports. MSMEs are the largest employer next only to Agriculture, providing employment to 110.9 million persons.

The success of the ambitious government initiatives like ‘Make in India’, ‘Skill India’ and Stand-up India’ rests solely on the development of the MSME sector. Re-iterating the symbiotic relation between MSME growth and economic prosperity, the sector’s significant contributions cannot be undermined. Right from employment creation, mitigating urban and rural divide, fuelling a balanced GDP growth, reducing imports to placing the economy on a global scale, the sector holds great importance.

Yet, despite these well-known facts, access to finance for small enterprises remains elusive till date. According to the International Financial Corporation (IFC), the total financing demand of the Indian MSME sector is approx Rs. 32.5 trillion. This includes entrepreneur’s contribution of INR 4.6 trillion and estimated external finance demand of INR 27.9 trillion.

In line with its mission to hit the $5 trillion-economy mark by 2025, the government has nonetheless deliberated to give a shot in the arm to the sector. One of its recent initiatives was targeted to bring relief to MSME borrowers registered under Goods and Services Tax (GST). Increasing the repayment period from 90 to 180 days along with changes in asset classification is a small yet a welcome move. Although these measures ensure that the formalisation of businesses doesn’t become a pain point for smaller enterprises, the MSME sector is longing for initiatives that will quench their thirst for financial support. Therefore, there exists an urgent need to address this concern and classify NBFC loans to MSME sector under PSL.

Let’s take the example of MSMEs in China. The sector accounts for about 58% of the country’s GDP and the Chinese MSMEs are responsible for over 80% of job creation and more than 70% of technological innovations. However, that is not the case in India. In order to boost the current growth pattern of MSMEs in India, lending to MSMEs in India should be made a priority in order to ensure consistent development of the sector and guarantee higher contribution to India’s GDP.

The need for better MSME financing

The MSME sector can reap greater dividends from a stronger alliance between NBFCs and the financial muscle of banks. At present, out of the total 63.3 million MSMEs in the country, less than 5 million have access to formal credit. This scenario can change drastically if MSME loans from NBFCs are classified under the Priority Sector Lending (PSL).

Mandated by the Reserve Bank of India, banks were allowed to achieve priority sector lending targets by refinancing NBFCs that focused on small ticket retail and SME loans. This suddenly changed in April 2011 when the RBI made banks’ refinance to NBFCs for on-lending to the MSME sector, ineligible for priority sector classification. As a result of this, the MSMEs still continue to grapple for working capital. With the loss of the PSL tag, financing to MSMEs has been affected tremendously.

Here’s a look at the bank wise loan (to the MSME sector) activity from Dec 2015-Dec 2017:

  • Public Sector Banks lending has decreased from 61.5% to 55.4%

  • Private Banks lending has increased from 25.4% to 28.5%

  • NBFCs lending to the MSME sector has increased from 7.9% to 10.4%

With approx. 4 lakh New to Credit (NTC) MSME borrowers entering the formal credit sector (up from 2.7 lakh borrowers from Jan to June 2016), the RBI needs to revise its priority sector lending classification again if a boost needs to be given to the economy.

A closer look at MSME financing by NBFCs

Given the small loan size, longer tenures, lack of digital and technical infrastructure and high expense involved in reaching out to the MSME sector, banks provide little to no help. Despite the emergence of certain NBFC lending platforms in the past five years, the financial woes of the MSMEs still continue. Therefore, NBFCs need a better grip on finer nuances of smaller players along with systematic and technologically advanced processes in order to assist MSMEs, in smaller towns as well.

Although, the above figures establish the important role that NBFCs are playing at present, they need to do a lot more to make the sector reach to its full potential which now warrants swift government action as well.

Concluding remarks

Charting a unique success story, the driver of India’s economic growth, the Micro, Small and Medium Enterprises (MSMEs) Sector, continues to live a paradoxical truth. Riddled by paucity of funds despite the inroads made by non-banking financial institutions, majority of MSMEs cannot offer substantial work experience, collaterals, infrastructure, or a larger ticket size to elicit interest of conventional banks, making financial inclusion a distant dream. In spite of the financial aid offered by the government and other relief measures, the SME sector is still reeling under a humungous credit deficit.

Considering the fact that the MSME sector is an important catalyst to overall economic development, classifying NBFCs loans to the sector under priority sector lending can work wonders. Increasing avenues of cash flows to MSMEs will be like hitting two birds with one stone, the latter’s financial inclusion and enhanced productivity.  

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