Credit and Finance for MSMEs: The fortunes of microcredit and micro-enterprises are closely interlinked. Restricted credit access and the high cost of borrowings for MSMEs can snowball into multiple negative consequences for the economy.
By Medha Girotra
Credit and Finance for MSMEs: Micro, Small & Medium Enterprises (MSMEs) are at the core of India’s future growth and a key component in the country’s resolve to emerge as a $5-trillion economy by 2025. Such enterprises account for about half of India’s exports, a third of the GDP, and a fifth of overall employment. Recognising MSMEs for their overall potential and as incubators of India’s entrepreneurial talent, the government has not only facilitated an enabling ecosystem but also provided active support through fiscal initiatives from time to time. Most recently, the extension of the Rs-5-lakh-crore sovereign-guaranteed credit facility for small businesses to the next fiscal year announced in the Union Budget 2022, will provide further support to their recovery from the pandemic.
Access to capital is a key challenge in the growth of MSMEs. Most small businesses are unable to apply for and get loans as they are unable to meet the collateral, asset, and paperwork obligations to secure short-term credit, or even a credit score to present with their loan applications. Due to the unavailability of loans, they are unable to build a credit history with the credit bureaus to show performance and capability to repay.
Statistics show that the microfinance network can empower entrepreneurs and communities that generally find it difficult to access formal credit from the banking sector. Microfinance can be the lifeblood for micro-entrepreneurial ventures and play a critical role in the quest for financial stability and growth of MSMEs. It can further fuel India’s entrepreneurial spirit by enabling easy access to credit.
Enabled by the government’s encouraging policy framework, the private sector is also partnering to provide microfinance solutions to MSMEs and accelerate their seamless shift to a future-proof digitized regime. Micro Finance Institutions (MFIs) today maintain a high degree of personal touch and regular interaction with borrowers and impart various skills related to entrepreneurship – especially financial skills, computer literacy, and market strategies, that not only facilitate easy access but also support the mission of eliminating the vast digital divide. With the help of digitization, the turn-around time is reduced, operational costs for the lenders are lowered, credit costs are cut down for the borrowers.
In addition, microfinance lenders customise their offerings and also support their customers to ensure that the disbursed loans are effectively utilised and deployed for the intended purpose. For instance, many MFIs launch specific products with repayment frequencies coinciding with the crop output cycles. This helps borrowers who are dependent on farm incomes, which are often prone to seasonal vagaries. Steps like these help MFIs control non-performing assets (NPAs) and encourage budding entrepreneurs to make the best use of their capital.
The government’s landmark reforms in fintech and digital payments – most notably the IndiaStack that comprises UPI, the Jan Dhan-Aadhaar-Mobile (JAM) trinity, and e-KYC – have helped simplify microfinance credit for those in need. On its part, the private sector is committed to investing its financial and knowledge resources to accelerate the transition.
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The fortunes of microcredit and micro-enterprises are closely interlinked. Restricted credit access and the high cost of borrowings for MSMEs can snowball into multiple negative consequences for the economy, namely, limited livelihood opportunities, reduced income levels and inequality, a spike in unemployment, high credit delinquency rates, and low private investment. On the other hand, as MFIs turn more job seekers into job creators, they help unleash several economic benefits for the country.
The right policy and regulatory incentives can also encourage MFIs to sustainably improve the supply of funding available to MSMEs. Flexible applications of capital adequacy and liquidity requirements across banks, by adjusting regulatory requirements based on the size and complexity of bank portfolios should be explored. These would enable smaller, less complex, non-international banks to increase funds for lending to close the credit gap, with easier access and at a lower cost. It would also be important to subsidize loan insurance for financial institutions which service MSMEs and transition to an internal rating-based (IRB) approach from a standard credit risk measurement approach that will incentivize banks to capture and utilize new, alternative sources of data on their loan portfolios, such as transactional and behavioural baseline data.
India’s micro-entrepreneurial spirit can flourish only if there is sufficient liquidity met through a vibrant microfinance ecosystem. This will help many deserving borrowers come into the ambit of the formal financial system. The goal of financial inclusion is to ensure that every individual can choose from a wide basket of financial products and services as per their requirements and preferences, without being limited by cost, location, or socio-economic considerations.
By providing adequate and timely tools and credit assistance to small entrepreneurs, the microfinance industry can fast-track our progress towards becoming a more socially and economically inclusive society.
Medha Girotra is the Vice President, Public Policy at Mastercard. Views expressed are the author’s own.