Credit and finance for MSMEs: The fortunes of microcredit and micro-enterprises are intertwined. Restricted access to credit and the high cost of borrowing for MSMEs can snowball and have multiple negative consequences for the economy.
By Medha Girotra
Credit and financing for MSMEs: Micro, small and medium-sized enterprises (MSMEs) are at the heart of India’s future growth and a key part of the country’s determination to become a $5 trillion economy by 2025. These businesses make up about half of India’s exports, a third of GDP and a fifth of global employment. Recognizing MSMEs for their global potential and as incubators of India’s entrepreneurial talent, the government has not only facilitated a favorable ecosystem but also provided active support through fiscal initiatives from time to time. Most recently, the extension of the Rs-5-lakh-crore Sovereign Guaranteed Credit Facility for Small Businesses until the next fiscal year announced in the Union Budget 2022, will provide further support to their recovery from the pandemic.
Access to capital is a major challenge in the growth of MSMEs. Most small businesses are unable to apply for and obtain loans because they are unable to meet collateral, asset and document requirements to obtain short-term credit, or even a credit score to submit with their loan applications. Due to the unavailability of the loans, they are unable to build up a credit history with the credit bureaus to show their performance and repayment capacity.
Statistics show that the microfinance network can empower entrepreneurs and communities that typically struggle to access formal credit from the banking sector. Microfinance can be the cornerstone of micro-entrepreneurial enterprises and play a vital role in MSMEs’ quest for financial stability and growth. It can further fuel India’s entrepreneurial spirit by facilitating access to credit.
Thanks to the government’s encouraging policy framework, the private sector is also partnering to provide microfinance solutions to MSMEs and accelerate their seamless transition to a future-proof digitized regime. Microfinance institutions (MFIs) today maintain a high degree of personal contact and regular interaction with borrowers and impart various skills related to entrepreneurship – especially financial skills, computer literacy and market strategies , which not only facilitate access but also support the mission of bridging the vast digital divide. With the help of digitization, turnaround time is reduced, operational costs for lenders are reduced, credit costs are reduced for borrowers.
In addition, microfinance lenders customize their offerings and also help their clients to ensure that disbursed loans are actually used and deployed for the intended purpose. For example, many MFIs launch specific products with repayment frequencies coinciding with crop production cycles. This helps borrowers who depend on agricultural income, which is often subject to seasonal fluctuations. Measures like these help MFIs control non-performing assets (NPA) and encourage budding entrepreneurs to make the best use of their capital.
The government’s landmark fintech and digital payments reforms – including IndiaStack which includes UPI, the Jan Dhan-Aadhaar-Mobile (JAM) trinity and e-KYC – have helped simplify microfinance credit for those who need it . For its part, the private sector is committed to investing its financial resources and knowledge to accelerate the transition.
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The fortunes of microcredit and micro-enterprises are closely linked. Restricted access to credit and high cost of borrowing for MSMEs can snowball and lead to multiple negative consequences for the economy, namely limited livelihood opportunities, reduced income levels and inequality, surge unemployment, high default rates and low private investment. On the other hand, as MFIs turn more job seekers into job creators, they help unlock several economic benefits for the country.
Adequate policy and regulatory incentives can also encourage MFIs to sustainably improve the supply of finance available to MSMEs. Flexible applications of capital adequacy and liquidity requirements in banks, adjusting regulatory requirements according to the size and complexity of banking portfolios, should be explored. These would allow smaller and less complex non-international banks to increase funds for loans to bridge the credit gap, with easier access and lower cost. It would also be important to subsidize loan insurance for financial institutions that serve MSMEs and to move to an internal rating-based (IRB) approach from a standard credit risk measurement approach that will incentivize banks capture and use alternative new sources of data on their loan portfolios, such as transactional and behavioral benchmark data.
India’s micro-entrepreneurial spirit can only flourish if there is sufficient liquidity through a vibrant microfinance ecosystem. This will help many deserving borrowers to enter the formal financial system. The objective of financial inclusion is to ensure that each individual can choose from a wide range of financial products and services according to their needs and preferences, without being limited by cost, location or socio-economic considerations. .
By providing adequate and timely tools and credit assistance to small entrepreneurs, the microfinance sector can accelerate our progress towards a more socially and economically inclusive society.
Medha Girotra is Vice President of Public Policy at Mastercard. The opinions expressed are those of the author.