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MSME Financing in India: Key to 5 Trillion Economy

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MSME Financing in India:
Key to the 5 Trillion
Economy
H K Pradhan
Pankaj K Agarwal

INTRODUCTION
Micro, small and medium enterprises (MSMEs)
are considered as the main drivers of economic
whose local supply chain comprises predominantly
the SMEs. Third, MSMEs have also played a
significant role in outlying regions and sectors,
8
growth in most emerging economies, providing a providing the necessary local content in the growth
major source of non-agricultural employment and process, thereby redressing regional imbalances. The
promoting entrepreneurship and innovation. The industrial clusters in and around larger enterprises
Indian MSMEs make up 90 per cent of all industrial in several parts of the country have a trickle-down
enterprises, contributing 31 per cent of GDP, 45 effect and displayed significant dynamism making
per cent of total industrial value added and 48 per productive use of local resources and facilitating
cent of merchandise exports in 2018–2019. The regional growth. Fourth, the promotion of MSMEs
present political ambition of lifting India’s GDP to with the provision of finance and other business
$5 trillion by 2025 envisages the contribution of development services helps to sustain social and
MSMEs to rise to 50 per cent by 2025.1 The Indian economic cohesion.
MSME sector is envisaged as the engine of growth The Indian MSME policy framework has evolved
and innovation as the government embarks on the with incentives, guarantees and directed credit with
‘Make in India strategy’ with focus on generating interest subventions, which together are aimed at
income and employment and keeping the export redressing the constraints in access to finance. A
sector competitive. However, despite promotion plethora of government initiatives are designed
and protection measures extended to MSMEs by so that MSMEs achieve economies of scale, and
the Government of India and the Reserve Bank of seize market opportunities and new technologies.
India (RBI), the sector faces several challenges such However, the realities on the ground could be
as investment constraints, inability to achieve scale vastly different for a large category of MSMEs who
economies and high failure rates, thereby requiring continue to face investment constraints, resulting
coordinated policy interventions in multiple fronts. in higher transaction costs and failure rates than
There are compelling reasons for a pro-MSME larger firms. Access to credit is not just important
growth strategy in India’s policymaking. First, a pro- for business continuity; it is equally vital for the
MSME strategy would act as the driver for growth MSMEs to stay competitive and innovative. In the
and would absorb expanding non-agricultural labor. case of the microenterprise units, which constitute
Second, the growth of small and medium enterprises almost 99 per cent of the enterprises in the MSME
(SMEs) is also linked to the overall growth of large space, financial constraints have been identified as
industries with significant backward and forward the primary reason for staying small. Strapped for
linkages. There is evidence of increasing trends funds, micro units get stunted and fail to reap the
towards interfirm linkages in production involving benefits of economies of scale, technology adoption,
subcontracting and outsourcing. There are also innovation and creating an asset base that is vital for
several instances of successful multinational firms their growth and survival.

Citation as: Pradhan, HK and Agrawal, Pankaj, "MSME Financing

in India: Key to 5 Trillion Economy", in Inclusive Finance India
Report 2021" Edited by Tamal Bandyopadhyay, Access Assist, New Delhi.
138 INCLUSIVE FINANCE INDIA REPORT 2020

DEFINITION OF MSME agricultural MSMEs engaged in different economic

activities, with 630.52 lakh (99%) enterprises in the
The canvas of the MSME sector is very broad
micro sector, 3.31 lakh (0.52%) in the small sector
comprising a heterogeneous group of enterprises.
and 0.05 lakh (0.01%) in the medium sector. Of
These enterprises encompass a wide variety of
the total number of MSMEs, 324.88 lakh (51.25%)
informal units, such as retail trade, restaurants,
are in rural areas, and 309 lakh MSMEs (48.75%)
metal workshops, auto-repairs, plastic and rope
are in the urban areas. The Indian MSME sector is
making, handicrafts and pottery producing an
characterized by the missing middle syndrome,2 a
innumerable number of products that form
situation whereby the micro firms fail to graduate to
the majority of the consumption basket of the
small- and medium-sized firms. Most of the Indian
households and businesses. Considering the wide
MSMEs are in the informal sector, therefore outside
diversity in a socio-economic environment within
the ambit of the formal trade and financial systems.
which the MSMEs operate and given the changing
The labour statistics also reveal that of the 450
scope and scale in their operation as determined
million workforces, 90 per cent are informal, and
by the technology, any uniform definition of
MSMEs employ about 40 per cent of these informal
these enterprises would be impracticable. There
sector workers.
is also no globally accepted definition of MSMEs;
As per NSS 73rd round, the MSME sector has
the European Union, for example, considers the
created about 11.10 crore jobs, with 3.6 crore jobs
number of employees, whereas the United States
in manufacturing, 3.9 crore in trade and the rest 3.6
defines MSMEs based on ownership structure and
crore in the service sector. Of the total employment
revenues. The classification should evolve in line
in the MSME sector, microenterprises employed
with the growth and transformation in the structure
1076.13 lakhs (97%) persons, with the remaining
and sophistication of the enterprise sector. The size-
31.95 lakh (2.88%) and 1.75 lakh (0.16%) persons
based criteria generally adopted are intended for
by the small and medium enterprise sectors,
the purpose of policy interventions and to identify
respectively. As per the self-declared information
the constraints and other forms of market failure as
filed online in the Udyog Aadhaar Memorandum
faced by the MSMEs needing intervention.
(UAM) since 2015, only 84.82 lakh MSMEs had
The MSMEs Development Act, 2006, categorized
registered by 15 January 2020. The UAM registration
enterprises based on investments in plant and
reveals that 89 per cent were microenterprises with
machinery, whereas the revised classification with
the remaining 11 per cent small enterprises and 0.5
effect from June 2020 adopts a composite criterion
per cent medium enterprises.3
based on investment and turnover (Table 8.1).
Table 8.1: MSME Classification

Revised Classification—June 2020

Classification—MSME
Composite Criteria: Investment and Annual
Development Act, 2006
Turnover

Service
Manufacturing Enterprises Manufacturing and Services
Enterprises

Investment < ₹ 1 crore

Micro < 25 lakh < 10 lakh
Turnover < ₹ 5 crore

Investment < ₹ 1–10 crore

Small 25 lakh–5 crore 10 lakh–2 crore
Turnover < ₹ 5–50 crore

Investment < ₹ 10–20 crore

Medium 5 crore–10 crore 2 –5 crore
Turnover < ₹ 50–100 crore

Source: The classification as per the guideline of the Ministry. Available at: https://msme.gov.in/know-about-msme.

COMPOSITION OF MSMES Most microenterprises are generally

As per the estimates provided by the 73rd National unregistered, belonging to the informal sector. The
Sample Survey (NSS) for the period 2015–2016, registered ones typically belong to the small and
there were 633.88 lakh unincorporated non- medium enterprise segment. For example, as per
 MSME Financing in India: Key to the 5 Trillion Economy 139

the Fourth All India MSME Census (2006–2007), to the data provided by the RBI, the banking
of the total 36.17 million enterprises 34.61 million institutions together offer about 17 per cent of the
were unregistered ones, and the balance 1.56 million industrial credit to the MSME sector and 40 per cent
were registered. Based on the classification as per the of the PSL lending.
MSMEs Development Act, 2006, the International
Finance Corporation (IFC) study reported 558 lakh
Working capital loans, short- and
MSMEs with 85 per cent as unregistered (Figure Banks Public,
long-term loans, overdrafts,
8.1).4 Private, Foreign
collateral financing

Manufacturing Registered Working capital loans, term

MSMEs MSMEs NBFCs
loans for fixed asset
11.7 million 8.2 million

Working capital loans, term

Total number of Small Finance Banks,
loans, microfinance, small
MSMEs NBFC-MFIs
ticket-size
55.8 million

Others (Cooperatives, Working capital loans, short-

Unregistered
Service MSMEs RRBs) and medium-term financing
MSMEs
44.1 million
47.6 million

VC, Risk capital, equity, start-up

Figure 8.1: Broad Classification of the MSMEs in India Private Equity finance

Source: IFC, Financing India’s MSMEs: Estimation of Debt

Requirement of MSMEs in India (2018). Available at: https://
www.ifc.org/wps/wcm/connect/region__ext_content/ifc_ex- DFIs SIDBI, Refinancing, equity infusion,
ternal_corporate_site/south+asia/resources/financing+in- MUDRA Bank credit guarantee instruments
dias+msmes+estimation+of+debt+requirement+of+ms-
mes+in+india (accessed on 6 January 2021).

Payment solutions, digital

There are significant regional variations in the Fintech
payments, crowd funding, P2P
distribution of the number of MSMEs with eight
states (Maharashtra, Madhya Pradesh, Tamil Nadu,
Figure 8.2: MSME Financial Architecture in India
Gujarat, Rajasthan, Uttar Pradesh, Karnataka and
Punjab) having 77 per cent of total enterprises. Source: Author.
Similar trends in regional variations are observed
in investment, employment and output of the Banks and non-banking financial companies
MSME sector (Annexure 8A). The flows of credits (NBFCs) report their credit flows by economic sector
would naturally follow the same pattern of regional to RBI. Based on the RBI data for the banking sector,
variations, determined by the MSME operations in the credit outstanding was ₹ 15 lakh crore for the
the states. MSMEs serving 3.8 crore borrowers as on 31 March
2020 (Table 8.2). The share of micro, small and
MSME FINANCING medium enterprises was 46.3 per cent, 41 per cent
India has evolved a robust credit architecture for and 12 per cent, respectively. In the MSME credit
the MSMEs (Figure 8.2) governed by the regulatory outstanding, banking sector dominates with 87 per
framework of RBI and the policy support of the cent, followed by NBFC at 9 per cent and foreign
Ministry of MSMEs. The credit delivery to the banks at 4 per cent (Figure 8.3). As expected, public
MSMEs by the banking sector comes under the sector banks have been the dominant lenders to the
rubric of the priority sector lending (PSL) guidelines MSME at 54 per cent. Within the MSMEs sector, the
of RBI. The landscape of MSME financing follows micro segment is the fastest-growing segment with
a multi-agency approach with direct lending by the about 93 per cent of the loan accounts in 2019–2020,
banking institutions at the core, such as the public rising from 80 per cent in 2017–2018. The small and
and private sector banks, foreign banks, co-operative medium enterprises, respectively, have 6 per cent and
banks and regional rural banks (RRBs). According 1 per cent accounts in 2019–2020.
140 INCLUSIVE FINANCE INDIA REPORT 2020

Table 8.2. Bank Credit to MSMEs (Number in Lakh, Amount in ₹ Crore)

Year Micro Enterprises Small Enterprises Medium Enterprises MSMEs
No. of Amount No. of Amount No. of Amount No. of Amount
Accounts Outstanding Accounts Outstanding Accounts Outstanding Accounts Outstanding
1 2 3 4 5 6 7 8 9
2018-19 255.6 6,59,102 23.03 6,38,031 2.6 1,97,419 320.68 15,10,651
2019-20 352.9 7,16,962 23.26 6,33,625 3.52 1,95,487 379.69 15,46,074
Source: RBI: Priority Sector Returns submitted by SCBs.

The credit information agency TransUnion

CIBIL obtains data on credit extended by the
9%
banking and NBFC sector at a more granular basis
4% with further credit disaggregation by loan sizes.
The total commercial credit exposure by banks and
NBFCs stood at ₹ 17.54 lakh crore as on 31 March
2020 (Table 8.3). The difference between the data
as reported by RBI and TransUnion CIBIL will
represent the contribution of the NBFCs. More
54%
granular data are provided by TransUnion CIBIL
33%
with the loan accounts between ₹ 1 and 10 crore
has the highest share of credit outstanding at 40 per
cent, followed by ₹ 10 and 25 crores at 19 per cent, ₹
25 and 50 crore at 15 per cent and the remaining 26
per cent shared among loan amounts up to ₹ 1 crore
(Figure 8.4). Micro loans below ₹ 10 lakh accounted
for just 1.3 per cent and loans between ₹ 10 and 50
lakh at 3.1 per cent of the total outstanding. Public
sector banks remain as the dominant source of credit
providers to the micro segment borrowers with loan
Public Sector Banks Foreign Banks Private Sector Banks NBFCs ticket size up to ₹ 50 lakh, holding almost 60 per
cent share in this segment. As can be seen from
Figure 8.3: Credit Flow to the MSME Sector by Category: December 2019 Table 8.3, the credit exposure across segments have
Source: RBI, Annual Report 2019-20, Chapter IV Credit Delivery and Financial Inclusion, remained somewhat stagnant or reduced marginally
August 25, 2020. in recent months.

Table 8.3: Commercial Credit Exposure by Banks and NBFCs (₹ Lakh Crore)

Micro2 Small Medium1 Medium2

Very Small Micro1 Large
₹ 50Lakhs-1 ₹ 1-10 ₹ 10-25 ₹ 25-50 Overall
<₹ 10 lakhs ₹ 10-50 Lakhs > ₹ 50 Crores
Crores Crores Crores Crores
Jun-18 0.78 1.91 1.3 6.51 3.27 2.67 44.9 61.33
Sep-18 0.82 2.02 1.37 6.84 3.38 2.75 48.93 66.11
Dec-18 0.85 2.1 1.42 7.04 3.45 2.78 49.99 67.63
Mar-19 0.88 2.18 1.48 7.29 3.55 2.87 52.33 70.59
Jun-19 0.88 2.14 1.45 7.23 3.48 2.79 51.79 69.77
Sep-19 0.89 2.2 1.47 7.25 3.47 2.78 51.5 69.57
Dec-19 0.92 2.23 1.5 7.33 3.48 2.77 51.49 69.73
Mar-20 0.93 2.19 1.45 7.02 3.33 2.62 52.03 69.58
Jun-20 0.91 2.17 1.42 6.81 3.18 2.46 50.09 67.03
Source: TransUnion CIBIL, MSME Credit Health Index (2020). Available at: https://www.transunioncibil.com/resources/tucibil/doc/insights/reports/re-
port-msme-chi-october-2020.pdf (accessed on 6 January 2021).
 MSME Financing in India: Key to the 5 Trillion Economy 141

Table 8.4: Direct and Indirect Credit Extension by

13%
SIDBI (₹ Crore)
15%
March 31, March 31,
8% 2019 2020
Indirect Credit 1,26,819 1,55,429
5%
Refinance to Banks,
19% 1,16,277 1,43,233
SFB, FIs
Assistance to MFIs 1,172 1,821
Assistance to NBFCs 9,370 10,375
40% Direct Credit 9,411 9,993
Loans and Advances 8,897 9,867
< `10 Lakhs `10 – 50 Lakhs `50 Lakhs – 1 Crores
Receivable Finance &
514 126
`1 – 10 Crores `10 – 25 Crores `25 – 50 Crores Bill Discounted
Source: SIDBI, Annual Report 2019-20 (2020). Available at:
Figure 8.4: Credit Exposure by Banks and NBFCs by https://sidbi.in/AnnualReport201920/pdf/Sidbi-AR-2020.pdf
Loan Size: March 2020 (accessed on 6 January 2021).

The MSME lending space has also witnessed new Micro Units Development and Refinance
entrants in recent years like the NBFC-microfinance Agency (MUDRA) Ltd, a wholly owned subsidiary
institutions (MFIs) and the small finance banks of SIDBI, has been engaged in refinancing of the
(SFBs); the latter was introduced in 2015 to focus lending institutions (banks, MFIs, NBFCs and SFBs)
primarily on financing at the bottom of the pyramid. against their loan portfolios under the Pradhan
SFBs have the mandate of 75 per cent of its adjusted Mantri MUDRA Yojana (PMMY). The MUDRA
net bank credit (ANBC) as PSL compared to the scheme was launched in 2015 to offer collateral-free
40 per cent for the universal banks. SFBs have loans up to ₹ 10 lakh to small and microenterprises.
predominantly microfinance portfolios, typically The three categories of loans envisaged under the
following their legacy lending models. SFBs are scheme are up to ₹ 50,000 (Shishu), up to ₹ 500,000
required to ensure that at least 50 per cent of its loan (Kishor) and up to ₹ 1,000,000 (Tarun). In 2019–
portfolio should constitute loans and advances of 2020, the public sector banks had disbursed 6.22
up to ₹ 25 lakh. Both NBFC-MFIs and SFBs, which crore loans of ₹ 3.82 lakh crore under the MUDRA
traditionally extended loans to the low-income scheme. The U. K. Sinha report recommends hiking
population, have enhanced their lending portfolios the limit of collateral-free loans to ₹ 20 lakh. The
in the microenterprise segment. NBFCs lending non-performing assets (NPAs) under this category
portfolios include fixed assets and working capital of loans have stood at 4.92 per cent in 2019–2020.
loans, which has risen from 6 per cent in 2008 to Rising NPAs in this portfolio does not augur well
10 per cent in 2019 in the total institutional credit for this ambitious MUDRA scheme, though might
to MSMEs. The emergence of Fintech companies, have helped many small and micro-entrepreneurs in
which are typically registered as NBFCs, have securing a livelihood.
accelerated the financing in the MSME segment
synergistically using innovative payment solutions. ESTIMATES OF CREDIT GAP
The Small Industries Development Bank of India IFC (2017) estimated the total financing demand
(SIDBI) extends institutional lending by way of of MSMEs in India at ₹ 87.7 lakh crore with ₹ 18.4
refinancing as well as sector support using the schemes lakh crore in equity and ₹ 69.3 lakh crore in debt
of the central government. SIDBI serves as the apex component. As can be seen from Figure 8.5, about 84
financial institution for the promotion, financing per cent of credit demand by the MSMEs in the debt
and development of MSMEs as well as coordinates component was being met by the informal sector
the implementation of government schemes. As seen comprising family, friends and family business,
from Table 8.4, much of SIDBI’s financial support is local moneylenders and chit funds. Thus, the formal
in the form of refinancing banks, SFBs and NBFCs, institutional credit accounted for just 16 per cent
though assistance in the form of direct lending and of the overall credit requirement of the MSME
equity infusion has grown (Table 8.4). sector. Scheduled commercial banks dominate the
142 INCLUSIVE FINANCE INDIA REPORT 2020

Total Supply of Debt to MSMEs

(₹ 69.3 trillion)

Formal Sources Informal Sources

(₹ 10.9 trillion) (₹ 58.4 trillion)

Scheduled NBFCs Other Government

Commercial (₹ 1.5 Banks Institutions
Banks (₹ 8.8 trillion) (₹ 0.56 (₹ 0.04
trillion) trillion) trillion)

Public Private Foreign RRBs UCBs SIDBI SFCs

Sector Banks Sector Banks Banks (₹ 0.3 (₹ 0.11 (₹ 0.45 (₹ 0.01 (₹ 0.03
(₹ 4.5 trillion) (₹ 3.1 trillion) trillion) trillion) trillion) trillion) trillion)

Figure 8.5: Overall Credit Supply to MSMEs in India

Source: IFC, Financing India’s MSMEs: Estimation of Debt Requirement of MSMEs in India (2018). Available at: https://www.ifc.
org/wps/wcm/connect/region__ext_content/ifc_external_corporate_site/south+asia/resources/financing+indias+msmes+esti-
mation+of+debt+requirement+of+msmes+in+india (accessed on 6 January 2021).

institutional credit supply with over 81 per cent share, whereas for services, it is merely about 0.1 for the
with the rest coming from NBFCs, RRBs, UCBs, year 2018–2019. The smaller enterprises depend to
SIDBI and SFCs. According to the IFC report, the a large extent on equity financing, predominantly
MSME sector faced an institutional credit shortfall coming from their owner/manager. As the firm
of ₹ 25.8 Lakh Crore in 2017, which translates into grows, there occurs a transition from equity to
only 30 per cent demand for credit being met. IFC debt financing. MSMEs, in general, do not fund
estimates the credit gap as the difference between the from external equity, as the owner/manager may
total addressable demand for external credit with the not accept dilution or external control, and in the
overall supply of finance from the formal sources, presence of information asymmetry, their stakes are
excluding credit demand from new enterprises as also not accepted by the outside investors.
well as from enterprises that do not seek formal
financing. The credit gap is huge, requires significant NPAs COMPARATIVES
policy push in several directions, as discussed in the Tables 8.5 and 8.6 present the recent trends in NPAs
present chapter. This calls for a concerted approach by the type of borrowers and lenders, respectively,
in augmenting the extant regulatory framework according to data from TransUnion CIBIL. The
along with government support and improved overall NPA rates continue to remain less for
financial architecture. the MSMEs as compared to the large borrowers’
Data on financials of the unregistered MSMEs category (Table 8.5). NPA ratios are generally
are not available. Based on the data available with observed to be higher for the loan segments with
the Centre for Monitoring Indian Economy (CMIE) larger ticket sizes. Despite the liquidity stress during
of the registered enterprises for the three financial the COVID pandemic, there is a marginal increase
years 2017, 2018 and 2019, we compiled the median in the NPA rates for all category of borrowers in
ratios of 1,229 manufacturing and 2,038 services June 2020 as compared to March 2020, much due
MSMEs, classified as per the MSME Development to the beneficial impact of loan moratorium. The
Act, 2006 (Annexure 8B). The data provides NPA rate on MSME loans of public sector banks was
important insights into the financial structure of the well above the range of NPA rates of private sector
registered MSMEs. The internal funds and retained banks and NBFCs (Table 8.6). According to the data
earnings constitute the main source of financing, released by the Ministry of MSMEs, the NPAs on
as most MSMEs historically were financed by account of MUDRA loans extended under PMMY
short-term debts and informal credits. The shares was 4.92 per cent in 2019–2020 (₹ 18,835 crore out
of external finance, such as equity and long-term of the total disbursement ₹ 3.82 lakh crore), up from
bank debt, were negligible. The median debt to 3.42 per cent in 2017–2018 (₹ 7,277 crore out of the
equity ratio for manufacturing SMEs is about 0.5, total disbursement of ₹ 2.12 lakh crore).5
 MSME Financing in India: Key to the 5 Trillion Economy 143

Table 8.5: NPAs by Types of Borrowers

March 2018 (%) March 2019 (%) March 2020 (%) June 2020 (%)
Very small (<₹ 10 lakh) 11.20 11.30 12.60 13.10
Micro-1 (₹ 10–50 lakh) 7.60 7.80 8.70 9.10
Micro-2 (₹ 50 lakh–1 crore) 7.70 7.70 8.60 9.00
Small (₹ 1.0–10 crore) 9.10 9.30 10.30 10.70
Medium-1 (₹ 10–25 crore) 12.90 13.70 15.60 15.60
Medium-2 (₹ 25–50 crore) 15.10 16.20 19.40 20.10
Large (> ₹ 50 crore) 17.70 16.70 17.30 17.30

Table 8.6: NPAs by Types of Lenders

Micro Small Medium

December June December June December June 2020
2019 (%) 2020 (%) 2019 (%) 2020 (%) 2019 (%) (%)
Public sector banks 11.70 12.5 17.70 16.6 29.20 27.3
Private sector banks 4.20 5.6 4.40 4.8 6.8 7.3
NBFCs 5.70 6.4 7.40 8.1 9.60 14.1
Source: TransUnion CIBIL. MSME Pulse (2020). Available at: https://www.transunioncibil.com/resources/tucibil/doc/insights/re-
ports/report-msme-pulse-april-2020.pdf (accessed on 6 January 2021).

The COVID pandemic has a detrimental effect structured to assist units in clusters where a change
on credit growth as well as credit quality across in the external environment has led to the MSME
several sectors of the Indian economy with severe loans becoming NPAs.
impact in the MSME sector. According to a report
by TransUnion CIBIL,6 in June 2020, the strength LENDING FRAMEWORK FOR MSME
index of MSME credit (measuring asset quality) LOANS
had sharply fallen by 14 per cent from its 2018 The prevalence of credit constraints facing Indian
levels whereas the credit growth index remains MSMEs has been widely acknowledged by the
flat. The credit growth would have fallen even regulators as well as lending institutions. The
more sharply but for the Emergency Credit Line policy framework to support a pro-MSME policy
Guarantee Scheme (ECLGS) of the Government of has evolved over the years with redefining the PSL
India to sustain credit delivery to MSMEs during guidelines, scheme of interest rate subventions,
the pandemic. partial credit guarantee, relaxing prudential
Sustaining credit growth of MSMEs requires norms for the lending institutions, creating new
addressing resolutions of NPAs and payment instruments for term loans, discounting of the trade
defaults, improving the risk appetite of the lenders. receivables and so on. MSME lending is separately
Given that a vast majority of micro and small categorized within the priority sector loans by banks
enterprises (MSEs) are very small in size and are to increase credit access. Extensive interventions
vulnerable to financial distress, NPA resolution involving financial system have been in place to
requires policy interventions from multiple fronts. bridge the gap in the financing of MSMEs. Plethora
One such suggestion has been through a provision of of initiatives have been launched in recent years
out-of-court assistance for NPA resolution provided that include Stand-Up India scheme, Udyamimitra
for under the Insolvency and Bankruptcy Code. portal of SIDBI, PMMY, mandatory buying of
The out-of-court assistance could be in the form of MSME products by public sector enterprises and a
mediation, debt counselling and financial education 59-minute in-principle approval scheme for loans
as recommended by the U. K. Sinha Committee. up to ₹ 1 crore for MSMEs and so on (see Box 8.1
NPAs arising out of adverse business conditions for a selective set of measures). The policy initiatives
also need to be dealt with differently. The U. K. facilitating access of credit to MSMEs can best be
Sinha Committee recommended that a distressed summarized in the statement of the Union Minister
asset fund be created with a corpus of ₹ 5,000 crore, of Finance in Rajya Sabha:
144 INCLUSIVE FINANCE INDIA REPORT 2020

Reserve Bank of India (RBI) and the the requirements arising due to unforeseen/
Government have taken several steps to ensure seasonal increase in demand, adoption of
access of credit to MSMEs, which inter-alia one cluster, operationalising at least one
include, advice to all Scheduled Commercial specialised MSME Branch in every district,
Banks (SCBs) to achieve a 20 percent year- simplified computation of Working Capital of
on-year growth in credit to Micro and Small MSE units to make it minimum 20 percent of
Enterprises (MSEs), allocation of 60 percent the Projected Annual Turnover of the unit for
of the MSEs advances to the Microenterprise borrowable limits up to ₹ 5 crore, setting-up
Accounts, a 10 percent Annual Growth of Trade Receivables Discounting System
in number of Microenterprise Accounts, (TReDS) to solve the problem of delayed
additional working capital limit to meet payment of MSMEs, etc.7

Box 8.1: Select Policy Initiatives Facilitating Credit Flows to the MSME Sector
• To enable easy access to credit for MSMEs, a 59-minute in-principle approval scheme for loans up
to ₹ 1 crore for MSMEs through the portal linked with GST was announced in November 2018.
Till September 2020, 213,639 numbers of loans, involving ₹ 67,569 crore have been sanctioned
and 198,720 numbers of loans, involving ₹ 55,229 crore have been disbursed.
• PMMY was launched in April 2015 for providing MUDRA loans up to 10 lakh to the non-farm
small/microenterprises to be extended by commercial banks, RRBs, SFBs, MFIs and NBFCs.
For the financial year 2019–2020, a total of 62,237,981 PMMY loans were sanctioned with an
aggregate disbursement of the amount of ₹ 329,684.63 crore.
• A scheme of interest subvention of 2 per cent for all GST registered MSMEs announced on 2
November 2018 for scheduled commercial banks, which included co-operative banks also as
eligible lending institutions effective from 3 March 2020 on fresh or incremental loans up to ₹ 1
crore.
• In August 2019, RBI allowed banks to classify the loans to NBFCs for on-lending to MSEs up to
₹ 20 lakh as priority sector loans.
• One-time restructuring of loans to GST registered MSMEs that were in default but ‘standard’ as
on 1 January 2019 was permitted until 31 March 2020, which is extended further until 31 March
2021.
• New floating-rate loans to MSEs extended by banks with effect from 1 October 2019 were linked
to external benchmarks, which included all floating rate loans with effect from 1 April 2020.
• The Credit Linked Capital Subsidy Scheme (CLCSS) which has been in operation facilitates
technology upgradation by providing an upfront subsidy of 15 per cent on institutional credit up
to ₹ 1 crore for the MSMEs in the specified 51 sub-sectors.
• Credit Guarantee Fund Scheme for MSE (CGMSE) operating under a trust named Credit
Guarantee Fund Trust for MSE (CGTMSE) provides the lending institutions with credit guarantee
up to 50/75/80/85 per cent of the credit facility in the event of an MSE borrower defaulting on a
collateral-free loan.
• The Emergency Credit Line Guarantee Scheme (ECLGS) is a 100 per cent credit guarantee by
National Credit Guarantee Trustee Company (NCGTC) to member lending institutions (MLIs)
such as banks and NBFCs, who, in turn, extend additional working capital enabling the MSMEs
to meet their operational liabilities during the COVID pandemic. The ECLG Scheme comes with
a pre-approved credit sanction of 20 per cent of the borrower’s total outstanding credit of up to
₹ 50 crore as on 20 February 2020.
• Three lakh crore rupees on 13 May 2020 with a one-year moratorium on interest payment
provided to MSMEs as immediate financial relief.
 MSME Financing in India: Key to the 5 Trillion Economy 145

The priority sector norms have been mandated the board of a bank to ensure that any price
metamorphosed significantly over the years in order differentiation is consistent with the bank’s credit
for the banks to increase credit access to this sector. pricing policy factoring RAROC. RAROC-based
The important ones include (a) the setting of targets pricing of MSME loans considers the expected risk of
and sub-targets under PSL on the basis of ANBC/ defaults and, at the same time, determining the risk
credit equivalent of off-balance sheet exposures, pricing in tandem with the level of risk undertaken.
(b) incentivizing flow of credit to underserved districts By combining the scorecard and risk-based pricing
by assigning additional weightage on such loan book, approach, banks can effectively lower the capital
(c) inclusion of fresh categories under PSL as well requirement by reducing the default risk as well as
as enhancement in the credit limit of the existing improve the portfolio quality.
categories, (d) bank finance for the start-ups (up to ₹ 50 The Basel-III norms have ushered in a more
crore), (e) inclusion of on-lending by banks to NBFCs stringent, risk-based Tier-I capital requirement
for the latter’s MSME portfolio within the individual regime for banks. These norms are expected to
bank’s total PSL and (f) allowing banks to acquire strengthen the capital quality and risk capture of
loans under direct assignment arrangements or invest banks, thereby impose higher compliance burden
in pass-through certificates backed by loans which for the MSME loan book. Basel norms impose
qualify the definition of PSL. The revised guidelines higher collateralization requirements which, in
issued in September 2020 is comprehensive,8 expected turn, may lead to reduced exposure of such banks
to align with the national priorities of focusing on to SMEs. For India, the presence of priority sector
inclusive agenda, as applicable to all the commercial norms and dominant state ownership of banks serve
banks including RRBs, SFBs and local area banks and to mitigate these potential adverse effects of Basel
co-operative banks. norms on SME financing. In January 2019, RBI had
Banks have been using various credit appraisal permitted banks a scheme for one-time restructuring
system in their loaning operations of the MSMEs. of stressed assets of MSME borrowers, expected to
One such method in vogue is the credit scorecard, boost funding to MSMEs and ease capital pressure
wherein the lender uses minimum cut-off scores on banks. To mitigate the burden of debt servicing
for automated loan approval or rejection of the due to disruptions on account of COVID pandemic
loan application. Credit scoring serves as a low-cost and to ensure business continuity, RBI had granted
method for the lender to evaluate loan applicants, moratorium and subsequently on term loans of all
which also reduces the turnaround time. commercial banks, financial institutions and NBFCs.
The credit scorecard system effectively arrives at Notwithstanding the elaborate framework to
standardized scores by appropriately weighing the support lending to the MSME sector, the ground
financial ratios such as liquidity, profitability, turnover realities pose significant barriers to the flow of formal
or activity, financial leverage and solvency ratios. credit. Despite such policy nudges, bank credit to
Research has shown that banks that implemented the MSME sector has not witnessed any significant
the credit scorecard system systematically increased growth over the years. The majority of banks
the availability of credit to SMEs, especially to the appeared to have remained in the vicinity of the RBI’s
smaller scoring ones. Basel norms permit banks to PSL limits. In addition to the overall quantum of
use scoring models of loans up to ₹ 5 crore, as rating credit, the distribution of utilization of credit is also
based models are complex. RBI also has permitted skewed in favour of medium and small sector. The
the banks to use the board approved credit scoring medium and small enterprises are better placed on
models in their evaluation of the loan proposals of the parameters of credit appraisal as they have a much
MSE borrowers.9 higher degree of formalization. The micro sector faces
Another area that has significant implications significant hurdles, as the institutional mechanism
on MSME loan pricing is the acceptance of the risk- of credit appraisal depends on several business
adjusted return on capital (RAROC) framework and parameters, availability of financial statements and
economic capital allocation on the basis of risks. The adequate and chargeable collateral, which are found
internal rating models that have been used to arrive to be wanting such enterprises. It, therefore, could
at risk pricing of the MSME borrower based on be inferred that bank approach lending to MSMEs
rating can be subjective. To bring transparency and as ‘good compliance’ rather than ‘good business’. In
fairness to the credit pricing framework, RBI in its addition, the sectoral and regional distribution of PSL
report on pricing credit (2014)10 mandated banks to appears skewed too. A relook on PSL guidelines by
base the interest rates charged to MSME customers instilling some flexibility to banks is likely to help the
consistent with their RAROC. Subsequently, RBI has cause of MSMEs better.
146 INCLUSIVE FINANCE INDIA REPORT 2020

Box 8.2: The Extant Framework of Bank Lending to MSMEs

The salient features of the framework as provided over the years by RBI for bank lending to MSMEs
include the following:
1. Appraisal: For units seeking a working capital limit up to ₹ 5 lakh, an appraisal is to be done
at a minimum 20 per cent of projected turnover as per method recommended by the Nayak
Committee. In addition, banks are required to financing working capital limit in every term loan
sanctioned to enable commercial production to start as soon as possible.
2. Collateral: For MSEs, no collateral for a loan up to ₹ 10 lakh, extensible up to ₹ 25 lakh.
3. Credit rating: External credit rating is not mandatory but encouraged.
4. Cluster financing: Cluster-based approach helps banks in dealing with homogeneous groups,
assesses risk better due to better information, enables better monitoring and leads to cost
reduction. Accordingly, banks have been encouraged by the regulator to open full-service
branches in MSME clusters, and each lead bank is required to adopt at least one cluster in
each district. By March 2017, scheduled commercial banks had about 3,000 specialized MSME
branches.
5. Revival/rehabilitation: A detailed framework for revival/rehabilitation of MSMEs exists for those
having loan limits up to ₹ 25 crore, including accounts under consortium or multiple banking
arrangements. Similarly, a framework for non-discretionary one-time settlement scheme also
exists.
6. National Mission for Capacity Building of Bankers for financing MSME Sector (NAMCABS):
To bring in the attitudinal change among bankers, RBI designed NAMCABS with training in the
credit-related issues of the potential entrepreneurs.
7. Certified Credit Counsellors Scheme: A Certified Credit Counsellors scheme was also launched
by SIDBI to assist the entrepreneurs in preparing financial plans and project reports professionally
enabling better credit decisions by the banks.

RECEIVABLES MANAGEMENT BY the overall limits, specifically for meeting payment

SMEs obligations in respect of purchases from MSEs
either on a cash basis or on bill basis.12 Banks have
The working capital of MSMEs, particularly
also been advised to closely monitor the operations
those operating as ancillary units, continue to
in the sub-limit by ascertaining periodically from
remain under liquidity strain owing to overdue of
their corporate borrowers, the extent of their dues
receivables. The CMIE data analysed by the authors
to MSME suppliers and ensuring that the corporates
indicate that the median average collection period
pay off such dues before the ‘appointed day’/agreed
for manufacturing MSMEs for the year 2018–2019 date by using the balance available in the sub-limit
is about 65 days and over 100 days for those in the so created. The Department of Company Affairs
services sector (Annexure 8B). The findings of a vide its notification in February 1999 amending
survey undertaken by RBI in 2019 reported that 44 Schedule VI of the (then) Companies Act, 1956
per cent SMEs in manufacturing and 27 per cent made it obligatory on companies to disclose in their
units in the services sector are facing the problem of balance-sheets the outstanding dues owed by them
delayed payments.11 Large buyers enjoy interest-free to SSIs for a sum of ₹ 0.01 million or more which
financing by delaying payments to SME ancillaries, are outstanding for more than 30 days.13 MSME
effectively exploiting their weak bargaining power Development Act, 2006, made a provision of penalty
and disproportionate reliance on a handful of (at if payment of dues to MSMEs by buyers delayed
times a single buyer) buyers. beyond 45 days, making it liable to pay interest
RBI has made it mandatory that while to MSME supplier. The government launched an
sanctioning/renewing credit limits to their large online portal Samadhaan in October 2017, enabling
corporate borrowers (working capital limit more than MSMEs across the country to directly register their
₹ 10 crore), banks will fix a separate sub-limit, within cases relating to delayed payments. Yet the legal
 MSME Financing in India: Key to the 5 Trillion Economy 147

recourse available to MSMEs is often not resorted The central government in 2018 made it
to, despite the legal provisions in force obligating mandatory for companies with turnover over ₹ 500
payments of dues. crore to register on TReDS. In January 2020, the
In 2014, RBI set up an online receivable government-mandated all Central Public Sector
discounting system called trade receivables Enterprises to bring their entire vendor network on
discounting system (TReDS). This platform offers TReDS and not to delay payments beyond 45 days.
the MSMEs a facility to discount receivables from The Government of India also announced14 in the
multiple financiers drawn against large buyers Budget 2019 that NBFCs, not registered as NBFCs-
(companies/public sector undertakings [PSUs]/ Factor, will be brought on the TReDS platform,
government). The MSMEs benefit by competitive through an amendment in the Factoring Regulation
rates due to auction mechanism and seamless data Act, 2011. All NBFCs would directly participate on
flow in addition to the elimination of paperwork (for the TReDS platform.
a description of TReDS see Figure 8.6). Currently, Despite these efforts, many buyers have yet to
there are three TReDS platforms in operation, onboard the TReDS platform. Many of those signing
namely SIDBI- and National Stock Exchange- on appear to have done so for compliance only. For
owned (NSE) Receivables Exchange of India Ltd, example, out of the 4,599 companies (having turnover
Mynd Solutions-owned M1xchange and Axis of more than ₹ 500 crore) which have been mandated
Bank-owned Invoicemart. A number of initiatives to register on TReDS,15 1,384 (30%) have registered
are underway to popularize TReDS usage. RBI has on TReDS at the time of writing this report. Similarly,
incentivized banks to participate in this platform by 155 out of 255 Central Public Sector Enterprises have
allowing them to classify financing through TReDs registered on TReDS by March 2020, only 32 had ever
under priority sector. In addition, RBI plans to done a transaction.16 Nevertheless, the turnover on
provide on-tap authorization to entities desirous of all three TReDS platforms combined touched ₹ 7,000
operating TReDs platform to increase their number crore in 2019 clocking a growth of almost 900 per cent
from the current three. over the previous year. The recent waiver of ₹ 10,000

Buyers Suppliers Financiers

Buyer –1 Platform operator Financier

Buyer –2 E-Discounting Financier

Platform

Buyer – m Financier

Platform Buyers Operates platform, Platform operator

operator introduce their facilitates settlement empanels
empanels suppliers multiple
buyers financiers

Figure 8.6: Trade Receivables Discounting System (TReDS)

Source: RBI, ‘Trade Receivables and Credit Exchange for Financing of Micro, Small and Medium Enterprises,’ (2014). Available at:
https://rbidocs.rbi.org.in/rdocs/Content/PDFs/MSMETCE19032014.pdf (accessed on 6 January 2021).
148 INCLUSIVE FINANCE INDIA REPORT 2020

fee for MSMEs to join TReDS by the Government of In order to administer different types of schemes,
India is also likely to boost onboarding further. government has set up National Credit Guarantee
The U. K. Sinha Committee had recommended Trustee Company (NCGTC). NCGTC operates the
the RBI to enable the MSME to check the credit following schemes targeted at MSME financing:
rating and Credit Monitoring Report (which would (a) Credit Guarantee Fund Scheme for Factoring,
have liquidity risk, repayment track and specific (b) Credit Guarantee Scheme for Stand-Up India
behaviour for their buyers) with the consent of their and (c) Credit Guarantee Scheme for Micro Units.
primary banker. This would enable the MSMEs to NCGTC is a joint venture between the Government
be able to make an informed decision on extending of India and SIDBI. The eligible lenders (MLIs)
credit to buyers. include commercial banks (public/private/foreign/
RRBs), NBFCs, financial institutions and SFBs. At
CREDIT GUARANTEE FUND the end of March 2019, the number of different
TRUST FOR MICRO AND SMALL types of MLIs was as follows:
ENTERPRISES (CGTMSE)
Lack of adequate collateral, particularly with Table 8.7: Types of Member Lending Institutions of
MSEs, has been another impediment in obtaining CGTMSE
institutional credit in India.17 In cases where either Total PSB PVSB RRB FB OFI NBFC SFB
the requirement of collateral has been mandated to
116 21 19 51 5 9 8 3
have been waived or is not available, institutional
lenders have not been comfortable in credit extension. Source: CGTMSE, Annual Report 2019. Available at: https://
www.cgtmse.in/Annual%20Reports/CGTMSEAR021219(With-
What will they turn to in the event of default? Credit
outcutmark)Eng.pdf (accessed on 6 January 2021).
guarantee comes in as a solution. It strengthens the
credit delivery and ensures the flow of credit to the It is interesting that out of 10 SFBs, only 3 have
MSE sector. It is almost two decades now when the taken the membership. This is in spite of the fact that
government launched CGMSE under a trust named eligibility norms for SFB wishing to become MLIs
Credit Guarantee Fund Trust for Micro and Small are benign. If more SFBs, which are specialized
Enterprises (CGTMSE), launched on 30th August banks catering to the MSE sector, join CGTMSE, it
2000. The guarantee, in this scheme, is provided to will certainly provide more comfort to them in credit
the individual borrower. There are many other credit decisions eventually leading to higher and deeper
guarantee schemes catering to a specific target group credit penetration. Although CGTMSE has been
(see Table 8.7). The Credit Guarantee Scheme (CGS) of seeing increased coverage in terms of guarantees
CGTMSE guarantees to make good the loss incurred approved (See Table 8.8), the average ticket size of
by a lender up to 50/75/80/85 per cent of the credit the guarantees remains much lower contrasted with
facility in the event of an MSE borrower defaulting on an eligible ticket size of ₹ 200 lakh. It appears that
a collateral-free loan. The credit facilities up to ₹ 200 improvement in claim settlement ratio of CGTMSE
lakh (term loan or working capital) are eligible. might lead to higher coverage.

Table 8.8: CGTMSE Performance

Guarantee No. of No. of Claims Claims Paid Recoveries Average Size
Year
Approved Guarantees Settled (Crore) Received (Crore) of Loan (Lakh)
2010 6,875 151,387 1,722 34.32 1 4.54
2011 12,589 254,000 2,731 59.09 3 4.95
2012 13,784 243,981 1,894 67.96 4 5.65
2013 16,062 288,537 11,231 175.53 10 5.57
2014 18,188 348,475 15,075 424.45 15 5.22
2015 21,275 403,422 29,595 716.98 31 5.27
2016 19,949 513,978 35,240 1,004.73 58 3.88
2017 19,931 452,127 39,605 1,034.00 126 4.41
2018 19,065 257,204 36,277 967.79 178 7.41
2019 30,168 435,520 38,947 816.55 210 6.93
Source: CGTMSE annual reports, authors own calculations.
 MSME Financing in India: Key to the 5 Trillion Economy 149

CREDIT RATING AND BUREAUS INNOVATIONS IN MSME LENDING

The information asymmetry plaguing the MSME- The MSME lending space has witnessed extensive
financial institutions’ credit interface delays innovations globally with lending products
underwriting and deprives the borrower of timely designed by unbundling several forms of risks
funds. If lenders do a microscopic appraisal of an and cash flow characteristics. Broadly termed as
MSE borrower, they incur huge per-unit processing structured finance, these innovations have taken
costs owing to small ticket size in general. In the form of securitization, leasing and factoring,
addition, the absences of adequate financial records/ value chain financing, etc. These products which
data and credit history of MSEs prevents lenders have been found extensive applications in corporate
from developing handy prediction models. Yet lending are now being tried out in the MSME
another issue impeding the credit flow to MSEs sector. These structured lending products have
is the absence of customized appraisal process for potential to scale-up access to formal finance, by
them. Often, lenders use the same appraisal criteria linking repayments to cashflows. A report drawing
they do for large firms leading to a downward bias in from the experience of Organization for Economic
resultant risk rating of MSEs. Co-operation and Development countries21
Despite a number of initiatives that have been highlights the need for broadening the range of
taken to minimize the information asymmetry instruments available for MSME financing using the
through credit rating agencies and credit bureaus,18 asset-based financing route.22 Some of the innovative
the system lacks a credible source for unambiguous financing instruments can be summarized in the
financial and non-financial information about following:
MSMEs. Institutional lenders rely on their own credit • Asset-based finance: In asset-based finance,
risk assessment models which vary from lender to
MSMEs can get funding on the strength of assets
lender. The elaborate models primarily designed for
like accounts receivables, stock, property, plant
large borrowers often lead to delays in credit decision
and equipment and land and building, instead
too. The U. K. Sinha Committee19 recommended the
of their credit rating. This method of finance is
PAN to be used as a Unique Enterprise Identifier for
particularly useful for younger firms who find it
the MSMEs linked to various data repositories and
difficult to access traditional credit owing to lack
could be used to pull out financial as well as non-
of track record. This method is already popular
financial information about an entity by institutional
lenders. The committee also recommended the in several European countries.
creation of an independent credit rating agency • Hybrid Financing: Hybrid financing has debt
under RBI monitoring for SMEs, which can provide and equity characteristics combined into a single
objective credit risk assessment in this sector. instrument and is closely linked to the life-
Accordingly, a Performance and Credit Rating cycle approach to SME financing. In the early
Scheme was announced by the government in stage, a firm may be entering the growth stage
2004–2005 to be led by National Small Industries of its life cycle with a potentially higher risk of
Corporation with provisions of reimbursement investment, and the firm would not have access
of rating fee by ministry of MSME. An external to debt or equity financing. Hybrid instruments
rating agency SME Rating Agency of India (since such as subordinated debt, convertible debt and
renamed Acuité Ratings and Research), dedicated mezzanine finance are found to be very useful.
and customized for SME sector, was also launched • Securitization: Lending based on receivables
as a joint venture between SIDBI, Dun & Bradstreet called as securitization has been extensively
and some banks in 2005. However, the full benefit used in SME financings such as working
of credit rating and credit guarantee schemes capital and letter of credit. For the SME’s who
could be forthcoming only by creating a credit-risk receive a purchase order usually seek bank
database of all credit events related to MSMEs. A financing against the order. The key issue in
similar database created in Japan has led to marked this lending decision does not remain confined
improvements in facilitating bank lending to to the performance of the enterprise but of the
SMEs.20 The database could be authorized to source collateral, which is receivable. Securitization
information from credit rating agencies, NBFCs, can have the potential to funding alternatives to
banks and even borrower themselves. The resultant SME borrowers by enabling them to turn assets
data could prove useful for generating default with predictable cash flows into new money.
scenarios not only for individuals but even for entire • Factoring: Factoring bundles credits and
sectors with the help of analytics. collections thereby facilitate the financing of
150 INCLUSIVE FINANCE INDIA REPORT 2020

high-risk SME borrower. Credit extension is 2019, only 200 SME stocks got listed on the dedicated
based on the value of the borrower’s accounts SME platform of India’s largest stock exchange NSE.
receivable. Under the arrangement the receivables There appears to be a palpable aversion to equity in
are purchased by the factor, the title of the goods MSMEs.
thus passing on to itself, rather than used as
collateral in the case of a securitized transaction. FINANCING START-UPS AND
Factors purchase receivables in a manner VENTURE CAPITAL
similar to the accounts receivable component The Government of India has launched schemes
of securitization. Factoring can be on a non- to promote setting up of start-ups with technology
recourse basis, whereby the factor assumes no focused innovation. Under Ministry of MSMEs,
claim (recourse) against the borrower, recourse 31 schemes are currently operating which provide
basis whereby the factor has a claim against its various incentives and support for the start-ups.
borrower for any account payment deficiency. One such schemes under ministry of MSMEs
MSMEs essentially outsource their collection known as ‘A Scheme for Promotion of Innovation,
activities to the factor.
Rural Industries and Entrepreneurship’ (ASPIRE)
• Trade credit: Extended by the suppliers
under which 73 livelihood business incubators
themselves, trade credit has certain advantages
and 16 technology business incubators have been
over bank credit. First, the supplier can assess
set up with a financing assistance of ₹ 64.22 crore
better the creditworthiness of the MSME buyer
as on date. A key objective of this scheme is related
due to the historical business relationship. The
to ‘creating a framework for start-up promotion
buyer usually is better credit disciplined due to
through SIDBI by using innovative means of finance
the fear of any future interruption in the supply. It
to enable ideas/innovation and to convert these into
has been found that accessing trade credit creates
commercial enterprises’. The government has also
borrowing history for the firms, thereby provide
positive signals to the institutional lenders announced a ₹ 50,000 crore fund of funds (FoF) for
regarding the borrower’s creditworthiness. equity investments into MSMEs, with ₹ 10,000 crore
• Leasing: Lease financing of capital equipment coming from the government itself. This is broadly
and technology has served as an effective modelled on a similar and reasonably successful
alternative to long term financing of corporate. scheme of SIDBI where about 80 per cent of the
Lease financing eases the collateral requirement corpus came from venture capital firms. Another
in long term borrowing, as the lessor retains the important feature of this FoF is nudging the MSMEs
ownership of the equipment being leased out to finally list on SME platforms like Emerge of NSE.
and permits the lessee (the small enterprise) There is no separate data available as to how
to use the equipment in exchange for periodic many venture capital firms financed the start-ups
payments. SME can access lease finance more which are registered as SMEs. Some reports23 have
easily than bank loans as the leasing company recently emerged where firms already registered as
emphasizes more on the cash flow generating start-ups have started registering as SMEs to be able
capacity rather than its credit history, collateral, to stay afloat with the help of government schemes
or net worth. Additionally, leasing also provides during COVID pandemic. SMEs on their part must
tax relief to the depreciation benefit on the asset meet the operational agility and innovativeness that
owned. these start-ups demand to obtain the institutional
Financial innovations such as the ones financing arrangements viz. recently announced by
reviewed here offer superior risk unbundling SIDBI of the collateral-free loans of ₹ 3 lakh crore
features, providing sufficient incentives to lenders and subordinated debt of ₹ 20,000 crore for stressed
to enhance credit access. Factoring and leasing are MSMEs. The start-up initiatives appear all over the
instances which have greatly facilitated financing place with different ministries running different
of informationally opaque high-risk MSME and sometimes overlapping schemes. The need for
borrowers, particularly in situations of week contract a centralized nodal agency cannot be emphasized
enforcement and insolvency norms. Though these more. The U. K. Sinha Committee recommended
innovations have huge potentials for enhancing SIDBI as a nodal agency, ‘should ideally play the role
credit access, the MSMEs in India appear to suffer of a facilitator to create platforms wherein various
from an aversion to alternate forms of financing. For Venture Capital Funds can participate and in turn
example, attempts to encourage equity financing create multiplier effect for providing equity support
in MSMEs has met with mixed success. By August to MSMEs.’
 MSME Financing in India: Key to the 5 Trillion Economy 151

CROWDFUNDING accounting, marketing and selling operations.

The long-standing constraint of proper book-
The U. K. Sinha committee recommended that the
keeping by MSMEs are being addressed by new,
Ministry of MSME may establish a ‘Non-Profit
efficient and affordable technology solutions, for
Special Purpose Vehicle’ to support crowd sourcing
example, billing software platform such as ‘Vyapar’,
of investments by SMEs. Accessing funds using
payment reminders like KhataBook and tracking
crowdfunding route does not require a bank to act
of receivables and payables by OkCredit. Another
as an intermediary but source unsecured funding
innovative software called Marg ERP which has
from a wider set of investors. Crowdfunding may
brought hitherto unimaginable power of ERP
be in the form of pre-orders, rewards, donations,
within the reach of MSMEs, significantly enhancing
debt, equity or financing in some hybrid form,
coordination across business functions leading to
depending on the contractual arrangement between
enhanced productivity. The increased transparency
the firm and the investor. Crowdfunding using
in bookkeeping and effective tracking of receivables
pre-orders, rewards and donations are treated as
and payables would likely have a salubrious effect on
non-financial funding are commonly used in the
credit assessments and eventually to access to credit
micro business sector. Online lending platforms
for MSMEs.
such as Crowdera, Wishberry, Anglepaisa, Lentra,
The emergence of artificial intelligence-enabled
Ketto and WealthBook and so on are increasingly tools is also making back-office tasks easier. Models
being used to pool loan pledges from the crowd for based on artificial intelligence (AI) and machine
funding an SME entity. The crowdfunding platforms learning (ML) are being developed, rely on alternate
are also evolving with more specialized services such data that may range from cash-flows to reputation
as due diligence, business development services and drawn out of the social media behaviour of the
scouting for partner investors for the project, that entrepreneur. Data are drawn from various social
come with the transaction fees and loan interest as and demographic sources which are able to bridge
charged by the online intermediary. Although three the information asymmetry problem of SMEs. The
countries such as China, the United States and the information processing is automated thereby saving
United Kingdom dominates, India’s ranked 14th time and human resources in processing smaller
in the global crowdfunding market with $547.43 loan applications, making the processing of loan
million in 2018, with a meagre market share of faster and cost-effective for the lenders to make
0.18 per cent, as reported by Cambridge Centre for credit decisions for the MSMEs.
Alternative Finance.24 RBI issued guidelines under Technology has shown incredible promise
the NBFC Peer to Peer Lending Platform (Reserve for overcoming and minimizing information
Bank) Direction, 2017, which formalized the online asymmetry and improve risk assessment of the
lending model. enterprises. For the MSME financing models to
be successful, intensive use of technology and the
TECHNOLOGY AND FINTECH adoption of cost-effective models of information
INNOVATIONS processing is required. Partnership between banks
At the risk of repetition, it is well known that and Fintech solutions provider in a symbiotic
information asymmetry is one of the chief causes relationship based on complementarities will
of the lack of institutional credit to SMEs. The really be a big boost to MSE lending. Admittedly,
problem gets even more acute owing to the under- technology adoption will remain a function of the
formalization of MSME sector. The traditional innovativeness and skill of the entrepreneur. As
credit assessment models typically rely on financial more young Indians turn entrepreneurial, these
information and collateral of the borrowing entity, innovative trends would strengthen in addition to
which are often not available with the MSMEs. The adoption of newer ways of working like co-working
enterprises in general score lower on collateral, spaces.
repayment capacity, financial literacy and systematic
bookkeeping. Technology has evolved to become GREATER ROLE OF SIDBI
more affordable over the years. Reforms such as Given the importance of MSMEs in the development
GST and the Jan Dhan Adhaar Mobile ecosystem process, both the government and the RBI have
have resulted in KYC authentication faster. been instrumental in creating newer institutional
The revolutionary Software as a Service (SaaS) arrangements for stepping up MSME credit access.
model is enabling MSMEs to bring about a digital There has been general recognition of the expanding
transform to their infrastructure, payments, role of SIDBI in MSME finance. In addition to its
152 INCLUSIVE FINANCE INDIA REPORT 2020

role as an apex Institution engaged in financing termed as structured finance, these innovations
and development of MSMEs, SIDBI has been have taken the form of securitization, leasing and
encouraged to address market failures in MSME factoring, value chain financing, etc. which are
credits, facilitating innovations and risk capital found to have a greater scope on the supply side
infusion. The U. K. Sinha Committee opined the than the traditional credit models. These structured
SIDBI to handhold private lenders such as NBFCs lending products have the potential to scale-up
and MFIs for deepening credit markets for MSMEs access to finance by linking repayments to business
in underserved districts and regions. The committee cashflows. These innovative products which have
observed that additional instruments for debt and been found extensive applications in corporate
equity would be required to help crystallize new lending are now being tried out in the MSME
sources of funding for MSMEs. SIDBI could develop sector. The use of credit score cards and RAROC
innovative financial instruments such as first loss approach have superior risk-mitigating features,
guarantees, pass-through certificates and so on to which can provide incentives to lenders to enhance
gradually take on the role of a market maker for credit access. The strengthening of legal framework
SME debt. The committee also recommended that under the SARFAESI Act with taking possession
the priority sector shortfall of commercial banks of assets used as collateral has improved the
be deployed with SIDBI on the lines of Rural environment of contact enforcement. Technology
Infrastructure Development Fund of National Bank has shown incredible promise for overcoming and
for Agriculture and Rural Development, who could minimizing information asymmetry and improve
on-lend this corpus as soft loans to state governments risk assessment of the enterprises. The partnership
for creating and developing MSME clusters. between banks and Fintech solutions provider in a
symbiotic relationship will be a big boost to MSME
CONCLUSIONS accredit access. Admittedly, technology adoption
The MSME sector remains vital as the government will remain a function of the innovativeness and
targets raising the level of GDP to touch $5 trillion skill of the entrepreneur. Apex institution like SIDBI
by 2025. Considering the importance of MSMEs’ engaged in financing and development of MSMEs
developmental role, both the Government of India should be encouraged to address market failures
and the RBI have been instrumental in creating in MSME credits, facilitating innovations and risk
a supportive regulatory framework and newer capital infusion.
institutional arrangements for stepping up MSME Within the MSME space, the micro business
credit access. The lending framework has evolved sector faces far greater hurdles in accessing credit,
over the years with progressively amending the specifically to bank credit and are more vulnerable
PSL guidelines complementing with schemes to liquidity and financial distress which was also
such as interest rate subventions, partial credit evident during the economic lockdown. The
guarantee, relaxation of prudential norms, creating standard credit appraisal process as applied to larger
new lending instruments, addressing delayed SMEs requiring business parameters, financial
payments and discounting of the trade receivables. statements and chargeable collateral is found to
Notwithstanding these elaborate frameworks to be wanting in the case of microenterprises with
support the MSME sector, the ground realities pose small size loan. Bankers face additional hurdles of
significant barriers to the flow of formal credit. The high transaction costs because of administering
credit gap is huge requiring more targeted policy small size loans, monitoring of repayments, and
push in several areas covering finance, technology, low information on the business operations of
and business development services. All these calls these micro businesses. Sustaining credit growth
for a concerted approach in augmenting the extant of the microenterprises requires improving the risk
regulatory framework along with government appetite of the lenders including drastic change
support and improved financial architecture. in the attitudinal front of the bank officials. More
More focused strategies needed to overcome focused attention is also needed with supporting
lending resistance to the MSME sector, addressing regulations in deepening credit markets for
information asymmetries, operational inadequacies, MSMEs in underserved districts and regions. There
and collateral shortfall. is an increasing demand for formalization and
The MSME lending space has witnessed compliance under the emerging digital ecosystem
extensive innovations globally with lending such as GSTN, UAM and Udyam registration
products designed by unbundling several forms system. The integrated onboarding system under
of risks and cash flow characteristics. Broadly Udyam initiative with the Trade Receivables
 MSME Financing in India: Key to the 5 Trillion Economy 153

Electronic Discounting System (TReDS) and the and documentation protocols have not boded well
government e-marketplace are expected to greatly with microenterprises, imposing additional costs,
benefit the bill discounting and the government’s thereby generating perverse incentives of staying
online procurement system. RBI’s revised PSL small and informal. To maintain the institutional
guidelines issued in September 2020 require the credit flows to the large micro business sector the
MSMEs to be identified as per the gazette notification government and RBI should consider somewhat
laying down the new process of classification and liberal documentation system with phase-wise
registration. Though desirable these compliance implementation programme.
154 INCLUSIVE FINANCE INDIA REPORT 2020

APPENDIX 8.1:
State-Wise Data of Medium & Small Scale Industries

State/Union Territory Number of Investments: Production: Employment:

Enterprises: NSS 73rd Fourth Census Fourth Census NSS 73rd round
round (2015-16), (2006-07), (2006-07), (2015-16),
in Lakhs ` Crore ` Crore in Lakhs
Andaman & Nicobar Islands 0.19 96.95 254.24 0.39
Andhra Pradesh 33.87 32,757.63 58,404.82 56.19
Arunachal Pradesh 0.23 937.48 1,101.73 0.41
Assam 12.14 6,941.15 13,403.27 18.16
Bihar 34.46 8,405.45 16,709.30 53.07
Chandigarh 0.56 607.05 1,888.55 1.29
Chhattisgarh 8.48 3,303.41 8,437.34 8.48
Dadra & Nagar Haveli 0.16 229.58 2,177.43 0.36
Daman & Diu 0.08 1,881.53 7,735.73 0.14
Delhi 9.36 10,164.54 29,672.34 23.01
Goa 0.70 3,820.19 8,147.46 1.60
Gujarat 33.16 1,66,753.60 55,306.91 61.18
Haryana 9.70 25,998.80 53,198.68 19.12
Himachal Pradesh 3.92 5,599.25 17,247.20 6.48
Jammu and Kashmir 7.09 8,475.28 16,035.39 10.89
Jharkhand 15.88 5,020.72 10,040.29 25.03
Karnataka 38.34 27,161.11 56,317.61 71.45
Kerala 23.79 44,353.53 74,821.73 44.92
Lakshadweep 0.02 17.30 20.01 0.03
Madhya Pradesh 26.74 10,530.40 34,388.44 49.25
Maharashtra 47.79 67,941.24 1,26,864.55 91.23
Manipur 1.80 646.03 1,094.70 2.92
Meghalaya 1.12 468.55 1,150.80 1.91
Mizoram 0.35 403.14 677.21 0.62
Nagaland 0.91 1,273.67 2,845.03 1.77
Odisha 19.84 12,284.89 29,075.42 33.26
Puducherry 0.96 1,135.29 5,771.99 1.84
Punjab 14.65 37,126.69 81,625.05 24.80
Rajasthan 26.87 25,452.90 50,004.43 46.52
Sikkim 0.26 72.16 189.76 0.45
Tamil Nadu 49.48 77,824.34 1,05,270.21 96.82
Telangana 26.05 . . 2.95
Tripura 2.11 661.73 1,177.84 40.26
Uttar Pradesh 90.00 56,161.03 1,11,089.69 165.38
Uttarakhand 4.17 6,014.98 16,187.64 6.60
West Bengal 88.68 39,433.22 78,880.05 135.54
ALL INDIA 633.92 6,89,954.86 10,77,212.86 1,112.71
Source: Ministry of Micro, Small and Medium Enterprises (MSME) & Ministry of Statistics and Programme Implementation
(MOSPI), Government of India.
 MSME Financing in India: Key to the 5 Trillion Economy 155

APPENDIX 8.2:
Median Values of Financial Ratios of MSMEs (CMIE Data)

Manufacturing MSMEs Medium (N=326) Small (N=271) Micro (N=632)

2016-17 2017-18 2018-19 2016-17 2017-18 2018-19 2016-17 2017-18 2018-19
Current Ratio 1.22 1.21 1.33 1.18 1.26 1.32 0.99 0.93 1.26
Debt/Gross Fixed Assets 0.71 0.66 0.55 0.72 0.65 0.52 0.77 0.78 0.56
Debt/Net Fixed Assets 1.32 1.29 1.00 1.28 1.21 0.90 1.27 1.38 0.98
Debt To Equity 0.59 0.62 0.66 0.77 0.56 0.49 0.25 0.14 0.61
Debtor Days 70.54 75.27 61.18 70.04 79.59 68.66 79.23 88.73 63.73
Debtor Turnover 4.86 4.60 5.91 5.02 4.41 5.28 3.41 2.96 5.61
DSCR Times 0.36 0.34 0.42 0.26 0.26 0.49 - - 0.45
ICR Times 2.33 2.57 3.04 1.64 1.88 3.07 1.50 1.50 3.29
Long Term Borrowings/ 0.24 0.19 0.39 0.00 0.00 0.40 0.00 0.00 0.26
PBITDA
NWC Days 76.44 75.79 80.31 86.86 90.64 84.27 111.49 137.85 80.68
NWC 5.60 7.10 79.95 1.55 2.90 85.40 0.20 0.10 37.60
NWC/Sales 0.09 0.10 0.11 0.07 0.12 0.10 0.10 0.12 0.09
PBDITA/NFA 0.35 0.34 0.38 0.28 0.28 0.39 0.02 0.03 0.38
PBITDTA/TA 0.08 0.07 0.10 0.05 0.06 0.10 - - 0.10
ROTA 0.55 0.73 2.33 - - 2.74 - - 2.55
Short Term Borrowings 9.30 10.80 162.35 4.45 4.40 150.80 2.45 2.30 136.75
from Banks
ST from FI 1.90 2.20 9.55 1.15 0.30 9.45 0.60 0.60 31.70
Total Short Term 11.90 13.60 167.30 6.80 6.10 148.85 2.70 2.70 126.55
Borrowings
Net Sales Dep Amor/Total 0.91 0.93 1.11 0.67 0.63 1.05 - - 0.98
Liabilities
Total Borrowings 22.00 24.85 262.20 13.10 14.25 253.20 6.00 6.30 199.20
Services MSMEs Medium (N=794) Service-Small (N=1040) Service-Micro (N= 204)
2016-17 2017-18 2018-19 2016-17 2017-18 2018-19 2016-17 2017-18 2018-19
Current Ratio 1.42 1.39 1.49 1.17 1.17 1.20 0.72 0.68 0.67
Debt/Gross Fixed Assets 0.48 0.49 0.47 0.44 0.51 0.49 0.15 0.14 0.00
Debt/Net Fixed Assets 1.00 0.97 0.99 1.00 1.00 1.11 1.00 0.50 -
Debt To Equity 0.15 0.16 0.15 0.09 0.09 0.07 - - -
Debtor Days 88.05 98.08 96.36 98.95 95.10 95.86 173.38 130.36 146.00
Debtor Turnover 3.71 3.28 3.41 2.80 3.00 2.65 0.44 - 0.10
DSCR Times 0.28 0.33 0.37 0.12 0.13 0.12 -0.04 - -
ICR Times 2.09 2.25 2.25 1.80 2.00 2.00 1.00 1.00 3.00
Long Term Borrowings/ - - - - - - - - -
PBITDA
NWC Days 32.11 25.87 34.61 43.29 35.57 39.58 120.86 121.67 91.25
NWC 3.00 3.20 3.80 0.50 0.40 0.60 0.10 0.10 0.10
NWC/Sales 0.17 0.16 0.19 0.14 0.13 0.15 0.46 0.21 0.33
156 INCLUSIVE FINANCE INDIA REPORT 2020

PBDITA/NFA 0.37 0.41 0.40 0.18 0.20 0.25 - - -

PBITDTA/TA 0.04 0.04 0.04 0.02 0.02 0.02 - - -
ROTA 0.22 0.35 0.29 - - - - - -
Short Term Borrowings 4.00 4.80 5.20 1.50 1.50 1.90 0.20 0.20 0.20
from Banks
ST from FI 1.00 1.70 1.30 0.65 2.10 3.00 - - -
Total Short Term 5.70 7.10 6.90 2.10 2.60 3.00 0.70 0.70 0.80
Borrowings
Net Sales Dep Amor/Total 0.46 0.42 0.38 0.29 0.27 0.23 - - -
Liab
Total Borrowings 10.10 11.40 10.80 3.90 4.30 4.50 1.00 1.00 1.30
Short TermBank and 0.86 0.91 0.66 0.15 0.04 - - - -
FI/Total Short Term
Borrowings

Source: CMIE (Centre for Monitoring Indian Economy), ProwessIQ Database 2020.

Annexure 2 contains a median values of various financial ratios of a MSME firms grouped by Medium, Small and Micro categories
for the most recent three years whose data was available. Panel-A covers Manufacturing MSMEs and lower Panel-B covers Services
ones. Since the CMIE Prowess database does not host MSME data separately, filters were applied on investment in Plant and
Machinery as per the pre-COVID definition of MSMEs prescribed by the Government of India to extract data. Data for Small and
particularly Micro enterprises was sporadically available. The ratios have their usual interpretation.
a
DSCR= Debt Service Coverage Ratio,b ICR = Interest Coverage Ratio,dPBDITA=Profits Before Depreciation,Interest, Taxes and
Amortization,cNWC = Net Working Capital, eNFA = Net Fixed Assets,@TA =Total Assets,FROTA = Return on Total Assets,GFI =
Financial Institutions

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