We Must Study The MSME Credit Gap Before We Can Fix It

Context: A ‘hammer looking for a nail’ approach of force-fitting available solutions  (credit default swap and interest derivatives) to misunderstood problems will not work in resolving the MSME funding problem.

Understanding MSME funding problem

• Credit access is better than widely perceived: As per the MSME ministry, India has 63.3 million MSMEs, out of which 34-36 million MSMEs already have access to formal credit (against the popular narrative of only 6-10 million MSMEs)
  • Commercial subscribers: As per TransUnion Cibil data, there are 9 million unique commercial borrowers.
  • Other borrowers: 14-16 million consumers with commercial-vehicle and business loans.
  • Micro-finance borrowers:3 million unique micro-finance borrowers, at least 25% of them are MSMEs.
• MSME credit gap: While sourcing bank loans, the MSMEs without any access to formal credit borrow from informal sources for their ‘cash’ transactions.
  • Formal accounts only have transactions captured by goods-and-services-tax data systems
  • Greater formalization could see MSME demand for formal credit jump by 30-50% (i.e., by Rs 8-15 trillion).
  • Moreover, borrower intent is a major driver of closing the estimated credit gap of Rs 8-15 trillion.
• New-to-credit (NTC) MSMEs: The problem they face is longer timelines for loan approval more than outright rejection.
  • As per TransUnion Cibil, India adds 0.6-0.8 million NTC commercial borrowers each year.
  • Scope for improving loan efficiency: Large lenders and fintech firms with proven techno-analytical abilities to use data to underwrite loan – consider fraud and credit risk to field investigations.
• Need for a shift in approach: Some need to renew focus, while others need to refocus and recalibrate.
  • Driving on digitization: Available credit and know-your-customer information is leveraged by lenders to digitize the process of lending to MSMEs.
  • Need for a wider range of products:g. 3-6 months term loans (short term) and expansion of unsecured business lending through banks with greater regulatory encouragement.
  • Scope of Public-private partnerships (PPPs): Required to provide credit access to the 27-29 million MSMEs that lack access.
    • Digitalization may enhance operational efficiency, reducing the acquisition cost of small-ticket borrowers while charging them lower interest rates.
    • A PPP model can be devised that uses a common ‘credit stack’ equipped with advanced artificial intelligence to offer loans to unserved MSMEs.