Backbone of India: Empowering MSMEs through financial inclusion

Micro, Small, and Medium-sized Enterprises (MSMEs) are pivotal contributors to economic growth, particularly in developing nations, where they play a pivotal role in the creation of employment opportunities and the advancement of global economic development.  

In India, MSMEs account for 30% of India’s Gross Domestic Product (GDP) and over 45% of the exports. These businesses, ranging from micro business entities to mid-sized manufacturers and export-oriented entities MSMEs are at the core of the value chain of Indian economy.

The expansion of the Indian economy’s social and economic sectors is greatly influenced by the MSMEs. MSMEs also aid in reducing the disparity in income distribution by providing individuals with numerous job possibilities and industrialising rural regions. The sector’s employment potential at minimal capital cost is its key advantage.

They provide significant contributions to the nation’s exports, employment and industrial production. For the country to move towards a quicker and more equitable growth, this sector is crucial. The MSME sector is considered a vital engine for achieving the vision of a developed India by 2047, envisioned in the concept of “Viksit Bharat 2047”. 

In light of the crucial role played by MSMEs in the growth story of India’s economy, this article makes an effort to investigate the relevance of MSMEs in India and how these businesses might contribute to inclusive growth. The article would try to end by bringing attention to the problems, difficulties and possibilities that MSMEs in India are facing .

Challenges for MSMEs

Access to Finance: Despite the significant contribution by the MSME sector to the Indian economy, several long-standing challenges have impeded the realisation of full potential of the sector, one of which being ‘access to finance’. The ‘vast’ informal nature of entities and absence of relevant data/ documents puts these small enterprises at a disadvantage in accessing formal finance from banks and other regulated Financial Intermediaries. 

Further, access to capital markets by MSMEs/ listing on SME exchanges is underpenetrated in India that may be on account of MSMEs shying away from growth to continue to avail benefits extended to the sector. Other reasons may include vulnerability to macroeconomic shocks impacting valuations of SMEs and lack of awareness regarding the procedure/ processes of listing on exchanges. 

It is important to make SMEs aware of the advantages of SME exchanges since listing norms for SMEs on these bourses are less stringent and designed to encourage SMEs for listing. Research indicates that SMEs listed in SME exchanges have better profitability ratios, return on assets, Debt-equity-ratios etc., when compared with smallest 25% of firms listed in main board .

High collateral requirements: High collateral requirement is a major hurdle for MSMEs seeking finances from banks/ financial Institutions. These businesses, often lack significant assets like land, buildings, equipment, others. This somehow restricts their ability to expand their enterprises ultimately hindering their growth. It also stifles innovation within MSME sector, businesses with promising ideas may not be able to secure funding to develop prototypes, conduct market research or adopt new technologies.

CGTMSE plays a crucial role in addressing the challenge of collateral requirement. In FY2024, CGTMSE crossed a milestone of ₹2 lakh crore of guarantee amount, increasing sharply by 94% year-on-year.

Limited financial literacy and managerial skills: Beyond the initial hurdle of securing capital, many MSMEs struggle with a lack of financial literacy and management skills. This creates a significant roadblock to their long-term success.

Many MSME owners lack the expertise to effectively manage cash flow. This can lead to poor budgeting practices, unnecessary spending, and difficulty gauging profitability. Without understanding financial instruments, they might miss out on better loan terms, supplier negotiations, or strategic investments that fuel growth.

Secondly, weak financial management skills can create operational problems. Inventory management suffers when financial data isn't properly analyzed. This can lead to overstocking, tying up capital, or understocking, which risks losing sales. Finally, debt management becomes a challenge. Without a grasp of financial concepts, owners might struggle to negotiate loan terms, potentially leading to high-interest burdens that stifle growth or even defaults that damage their creditworthiness.

Regulatory compliance burden: Indian MSME sector, faces a constant hurdle and web of regulations. Complying with regulatory requirements sometimes eats away valuable time and resources of MSMEs and the regulators are constantly working on solutions.

Initiatives like streamlining regulations, offering online filing platforms, and providing temporary exemptions for startups aim to ease the compliance burden. Uneven implementation across states, limited awareness of support mechanisms among MSMEs, and the inherent complexity of the regulatory landscape itself pose hurdles that need to be addressed.

Overall, while positive steps are being taken, further simplification and improved outreach are crucial to create a more supportive environment for India's vibrant MSME sector to flourish.

Market competition and globalization challenges: MSME sector, a vibrant hub of entrepreneurship, finds itself on a tightrope walk with globalization. On the one hand, foreign companies, armed with advanced technology and economies of scale, pose a significant competition.

They sometimes undercut Indian MSMEs on price and quality, this fierce competition can be intense, limiting market share and pushing MSMEs to constantly innovate just to stay afloat. Keeping pace with ever-evolving consumer preferences across the world further adds to the challenge.

However, globalization isn't all gloom. It presents exciting opportunities as well. MSMEs can now showcase their unique products to a much larger audience, expanding their reach beyond domestic borders. This opens doors to untapped markets and potential for significant growth. 

Furthermore, increased interaction with international players fosters knowledge exchange. Exposure to new technologies and ideas can inspire innovation, allowing MSMEs to improve their efficiency and product quality.

Financing opportunities:

The Government is taking significant steps to bridge this gap of availability of finance to MSMEs. The foundation laid by GoI in the form of Public Digital Infrastructure- ‘India Stack’, is a robust and unrivalled digital infrastructure that has promoted innovation in financial services and furthered the agenda of financial inclusion.

The various digital rails of India Stack are now the foundation of creative tools being developed for improving flow of credit to the MSME sector. The solutions have not only eased access to credit for the MSME sector but have also enriched the MSME credit underwriting by lenders. Digital lending has promoted faster processing of loans, accelerated digitization and improved efficiency and cost of credit for the MSMEs. 

The emergence of Fintechs and the unique tech-based lending model is improving the reach of financial services to larger population and remote areas. Fintechs are actively sourcing New to Credit Customers. The Fintech lending models have also got a fillip from the increasing use of digital payment apps and the growing proclivity of younger generation for e-commerce and online payment solutions. Estimates suggest that India's digital lending market was worth $270 billion in 2022  and the Indian Fintech market is expected to reach $1 trillion in Assets Under Management by 2030 .

Innovations driven by new-age Fintechs/ NBFCs and rapid adoption of digital systems/ automation in processes by banks and other Financial Intermediaries are improving the flow of credit to the MSME sector. For example, leveraging analytics and various digital data points spread across a company's operations, such as credit scores of MSMEs by Credit Bureaus, Goods and Services Tax (GST) returns, Income Tax returns, transaction data from UPI/ PoS terminals, sales via e-commerce platforms, etc., a 360-degree view of a MSME borrowers is achievable. 

Additionally, due to advanced data analytics supported using AI/ ML and the digital pathways mentioned above, financial institutions are moving to scorecard-based risk assessment of MSME borrowers enabling objectivity and increasing the efficiency of lending to the MSME sector. Such an approach has sparked renewed interest in lending to the MSME segment, which has traditionally been viewed as risky by lenders. 

GST returns offer rich data and can be instrumental in bridging the information asymmetry for the MSME sector. Data analytics for cashflow assessment of MSMEs basis GST has enabled quick turnaround of loans for MSMEs.

Another advantage of the fast-growing digital lending landscape is the extension of financial products via non-financial platforms i.e., embedded finance. Bigtech/ large e-commerce platforms can analyse the inventory, receivables etc., to extend finance to small businesses through lending partners. It is estimated that embedded banking for SMEs could capture up to 26% of global SME banking revenue by 2025 . Also, embedded finance options have the potential to push up sales/ revenue of businesses including MSMEs.

The Open Credit Enablement Network (OCEN) & Account Aggregator (AA) framework shall be other significant additions to the layers of India Stack. These additions shall enable formal credit to flow at a relatively faster pace to the most vulnerable groups, particularly small businesses, with shorter repayment periods if desired. These platforms shall also provide financial institutions with an opportunity to reach large groups at lower cost of services/ distribution. 

The Open Network for Digital Commerce (ONDC) is also providing opportunities to small entrepreneurs to participate in booming e-commerce space thus eliminating barriers to entry. With ONDC facilitating all service providers at one place including logistics services, the platform truly possesses the potential to revolutionize digital commerce, both domestically and internationally. 

The support provided by GoI to the Indian startup ecosystem has positioned India as the third largest startup ecosystem in the world, behind USA and China. GoI initiatives such as Fund of Funds for Startups (FFS) of DPIIT, Self-Reliant India Fund, Startup India Seed Fund Scheme, Credit Guarantee Scheme for Startups etc., have led to the flourishing of startup ecosystem. 

SIDBI’s Digital Interventions for MSMEs

Small Industries Development Bank of India (SIDBI) has been established under SIDBI Act, 1989 to serve as the Principal Financial Institution for Promotion, Financing and Development of the MSME sector and co-ordination of the functions of the various Institutions engaged in similar activities. SIDBI started operation on April 02, 1990.

SIDBI operates various schemes for financing and promotion and development of MSMEs. Financing schemes are broadly classified into (1) Indirect Finance/ Refinance and (2) Direct Finance. Under Indirect Finance, assistance to MSMEs is extended through Banks (including SFBs), NBFCs, MFIs and other institutions by extending refinance/ resource support assistance against MSME portfolio of such institutions. This creates a multiplier effect and increases the flow of credit to MSMEs. Under Direct Assistance, SIDBI extends financial assistance directly to MSMEs through its branch network. 

SIDBI has been a leader in developing several digital interventions/ platforms for facilitating finance and other services for the MSME sector. Initiatives such as StandUp India Portal, Udyamimitra Portal, ‘PSBLoansin59minutes’ and TReDS platform, facilitate credit and handholding support to various sections of the MSME sector. 

In recent past, SIDBI has pivoted towards digital lending and is repositioning itself to become a leader in tech-driven solutions for the MSME sector.

SIDBI has delivered several digital interventions aimed at the diverse needs of the MSME ecosystem. Few of these recent digital initiatives are-Formalisation of Informal Micro Enterprises (IMEs) through Udyam Assist Platform (UAP): The aspirations of enhancing MSME contribution to GDP and exports necessitates integration of micro/ informal entities with formal channels that can be achieved through digitalisation. In a bid to enable formalisation of the high informality present in the MSME sector, MoMSME and SIDBI launched the Uydam Assist Platform to enable formalisation of Informal Micro Entities (IMEs) and establish credit & market connect for such enterprises. IMEs with an Udyam Assist Certificate shall be treated as Micro Enterprises under MSME for the purposes of PSL classification. 

Formalisation of informal sector is expected to bring them within the reach of various Government schemes and interventions including increased access to credit. The platform has already facilitated registration of over 1.85 crore IMEs. Formalisation project would have multiplier effect on IMEs resulting in exponential growth of these IMEs and much higher contribution towards national GDP.

GST Sahay Project: SIDBI, in association with Online PSB Loans Ltd (OPL) and iSPIRT, has developed a reference GST Sahay App using the Open Credit Enhancement Network (OCEN) and Account Aggregator (AA) frameworks for providing ‘on tap’ invoice-based financing (cash flow based) for small value credit to micro enterprises. The app journey is paperless and covers the entire credit life cycle from origination to repayment. It uses trade information from GSTN, Bank information through AA, Credit bureau status, etc., and other components of India Stack like e-sign and e-stamping, e-NACH mandate, etc. to achieve paperless process.

Collateral free/ unsecured small value loans to Micro Enterprises basis GST invoices will encourage more and more Micro enterprises to come under GST framework and would result in growth of the Micro Enterprises. Presently, 9 white lable lenders have rolled out the application on their platforms. Further, 2 lenders are in readiness for rollout and another 6 are in UAT stage of the testing.  

FIT (Finance, Income and Trade) Rank: Under the mentorship of SIDBI, CIBIL along with Online PSB Loans Limited (OPL), have launched FIT rank leveraging the power of GST, Bank Statements, and Income Tax returns (ITR) information to provide a ranking model for MSME lending. The ranking model uses machine learning algorithms to arrive at probability of an MSME becoming a non-performing asset (NPA) in the next 12 months based on its financial, income, and trade data on a scale of 1 to 10 with FIT Rank 1 for the least risky MSME and FIT Rank 10 for the most at-risk MSME.

Each FIT rank corresponds to a Probability of Default (PD) and the higher the FIT Rank, the lower is the PD associated with the MSME. Under the scope of the initiative, the Bank had launched a new product viz. “EXPRESS” to cater to the machinery/ equipment finance requirements of MSMEs. The product framework envisages automated evaluation based on FIT score /CIBIL MSME Rank (CMR) & JOCATA composite index of the entity and CIBIL credit vision score of promoters.  
 
SIDBI’s Other Interventions for MSMEs

Green Financing: SIDBI has forayed into green lending space and is aiming to emerge as the ‘Green Bank’ of India offering financial and non-financial solutions and taking leadership, in thought and action in respect of Green Finance.

To embed green investment as a culture in MSMEs', SIDBI revamped its schemes to finance the Green, simplified the processes, digitized access, and provided handholding support to the value chain on each green loan proposal. The focused green schemes of SIDBI are (i) End to End Energy Efficiency (4E Financing) Scheme, (ii) Express Green Power for Sustainability (e-GPS Scheme), and (iii) Green Finance Scheme.

Venture Financing: SIDBI has also been creating an enabling ecosystem for startups through support to venture capital funds and new fund managers, focused on MSMEs and startups. The SIDBI managed Fund of Funds for Startups of DPIIT, GoI, amounting to Rs 10,000 crore has transformed the landscape of startup and Venture Capital ecosystems by catalyzing four times that amount through the AIFs.

SIDBI has also developed the Startup India Investor Connect Portal to bring together startups and investors on a single platform, thus democratizing access to finance by startups located anywhere including Tier 2 cities and beyond. The Bank is also working towards filling the funding gaps in pre-seed/ ideation stage startups in collaboration with incubators. The Bank has also initiated a Venture Debt program for startups having funding needs between two rounds of equity capital/ in need growth capital without significant dilution.

The above interventions of SIDBI, and several other interventions under development, are expected to improve the credit flow to the underserved/ unserved MSMEs and give impetus to their growth. These interventions shall play a pivotal role in making informal/ small entities key players in the vision for the Indian economy. 

We are witnessing a point of inflection in lending towards the MSME sector. Technology has been the fulcrum in altering the perception towards financing MSMEs. However, the benefits of such movements are yet to be absorbed fully by the sector, particularly by the informal micro enterprises. 

Unlocking access to finance for MSMEs shall be key in enabling MSMEs to become the cornerstone of the $5 trillion economy. The ongoing digital revolution along with the commitments of GoI to enhance ease of doing business shall be fundamental in channelising large scale investments for economic development of which the MSME sector shall be one of the key beneficiaries.

Further, the continuous need-based improvements in the credit dispensation processes of MSME sector shall also enhance the flow of credit and production capacities of the MSMEs. Therefore, conscientious efforts need to be undertaken and encouraged to reach the enterprises operating in the farthest corners of the country. Towards this end, SIDBI stands committed to innovate and undertake interventions to reach the last mile and support the MSME sector that forms the bedrock of the nation.

Views are personal. The author is Deputy Managing Director at Small Industries Development Bank of India (SIDBI)