Micro, Small, and Medium Enterprises (MSMEs) are a significant part of the Indian economy. The export value of MSME-related products for the financial year 2024-25 alone constitutes 45.79% of all India exports.
However, despite their importance, MSMEs face significant challenges in finding financial support. According to an International Finance Corporation (IFC) report, the barriers include:
- Limited Collateral: MSMEs often lack assets to secure loans.
- High Transaction Costs: Small loans are costly to process.
- Low Financial Literacy: Entrepreneurs are often unaware of financing options.
- Risk Perception: Lenders view MSMEs as high-risk due to a lack of credit history.
- Inadequate Policy Support: Limited frameworks for innovative financing mechanisms.
This article explores the opportunities and challenges for lenders in the MSME segment, traversing innovative lending models, regulatory changes, and the impact of digital transformation in MSME financing.
Significance of MSME Loans in Economic Growth
MSME loans help small businesses to scale, create jobs, and contribute to the national GDP. They contribute approximately 30% of India’s GDP and employed more than 12 crore people in the last five years. Financial inclusion for MSMEs helps to improve regional development and industrial diversification.
This grassroots-level development is essential for driving national progress in the long run. For instance:
- Small businesses in local areas create jobs, reducing unemployment and boosting the local economy. Development at the grassroots level helps lift people out of poverty, contributing to overall national well-being.
- Better local health services improve overall public health, reducing national healthcare costs. Local producers find new markets for their products, increasing national trade and exports.
- More people gaining access to banking services at the local level strengthens the national financial system.
In view of this, government initiatives like the Pradhan Mantri Mudra Yojana (PMMY) and the Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) have greatly improved credit accessibility for MSMEs. However, these schemes alone are not enough to close the credit gap of 20 to 25 lakh crore in the sector.
Digital lending platforms can help bridge this gap by simplifying the loan application process, making it faster and more accessible for small businesses.
AI-based credit scoring and blockchain technology can help in securing the loan application and procurement process.
However, despite these advances, many MSMEs still face challenges in securing financial support.
6 Challenges in Obtaining MSME Loans
Despite their economic significance, MSMEs often struggle to secure financing due to structural and systemic barriers. As of 2023, only 14% of MSMEs in India have access to formal credit. Let’s look at some of the major roadblocks:
1. Lack of Financial Knowledge
Small businesses often require support in managing their financial records effectively to apply for MSME loans or interact with banks. Many small business owners may not be fully aware of the financial products and schemes available to them.
Financial training programs and partnerships with fintech platforms can help bridge this gap with MSMEs and financial bodies.
2. Limited Access to Modern Financial Solutions
Traditional banks are hard to access for MSMEs in rural and semi-urban areas. Many businesses also face problems with digital financial services due to poor internet or lack of infrastructure.
Expanding internet access and digital literacy in these areas will help more MSMEs benefit from online lending platforms and improve financial inclusion.
As of March 2024, over 4 crore MSMEs have registered on the Udyam portal, which facilitates access to credit and financial services through digital platforms.
3. Lack of Trust from Lenders
Many MSMEs operate informally, which causes lenders to be wary. Without proper records or a formal credit history, banks are less likely to lend MSME loans.
Fintech tools like AI-based credit scoring and using alternative data (like utility bills or online sales) are helping lenders assess risk more accurately, improving trust.
4. Collateral Requirements
Collateral is a big problem when applying for many MSME loans. Small businesses often don’t have enough physical assets, and banks are reluctant to offer unsecured loans.
Some government programs and fintech solutions now use other forms of security, like cash flow projections or digital payment history, to make financing more accessible.
The loan portfolio for MSMEs has seen a growth of 17.8%, reaching approximately ₹64.1 trillion by March 2024, driven by the rise of fintech solutions.
5. Outdated Technologies
Many small businesses still use old technologies. These businesses may struggle to qualify for MSME loans because banks prefer digitally-enabled businesses.
Adopting new technologies and using affordable digital tools for accounting, inventory management, and customer relations can greatly benefit these MSMEs.
6. Strict Regulations
Loan approval processes are complicated, with lots of paperwork. This discourages small businesses from applying for MSME loans.
Simplifying this process through digitisation and regulatory reforms would make it easier for small businesses to access financing.
Efforts like digital KYC (Know Your Customer) and single-window clearance systems are helping to make the regulatory process smoother. Also, the 59-minute MSME loan approval scheme has sanctioned over 2.23 lakh applications with a 93% disbursement rate.
Redefining MSME Financing with Innovative Lending Models
These creative lending methods are showing great potential in helping MSMEs overcome their financial challenges:
1. Peer-to-peer Lending
Peer-to-peer (P2P) lending platforms directly connect lenders with MSMEs. Bypassing traditional financial institutions reduces borrowing costs for small businesses.
A P2P lending platform uses advanced algorithms to match lenders and borrowers. This model offers flexibility and competitive interest rates, attracting borrowers who are underserved by conventional banks.
2. Crowdfunding Solutions
Crowdfunding platforms enable MSMEs to raise capital from a broad audience. MSMEs showcase their business potential through compelling campaigns and secure funds through a network of supporters. This model also allows entrepreneurs to validate their ideas and gain market insights before scaling their businesses.
3. Revenue-based Financing
Revenue-based financing provides MSMEs with capital in exchange for a percentage of their future revenue. Unlike traditional loans, this model does not require fixed monthly payments.
This is a suitable lending model for businesses with fluctuating cash flows. RBF is particularly useful for startups and small enterprises with strong growth potential but limited assets.
4. Supply Chain Finance
Supply chain finance provides working capital to MSMEs based on the strength of their receivables. This model improves liquidity and reduces dependency on collateral-based loans. This model improves the cash flow management of MSMEs and maintains smooth operations, even during economic uncertainties.
5. Digital Lending Platforms
Digital lending platforms leverage technology to offer quick, paperless loans. These platforms use AI and data analytics for credit assessment and risk management. Digital platforms reduce paperwork, speed up approval times, and allow businesses in remote areas to apply for MSME loans without needing to visit a physical bank
Recent Shifts in MSME Lending
The need for faster and more accessing financing solutions changes the way in which businesses approach MSME loans. Let’s take a look:
Rise of Alternative Financing Options
Alternative financing options have become increasingly popular among small businesses, especially MSMEs. Traditional loans are often difficult to access due to strict requirements and long approval processes.
As a result, alternative options like invoice discounting, merchant cash advances, and venture debt are gaining momentum.
These options provide MSMEs with greater flexibility, faster funding, and less reliance on traditional credit scoring systems.
Digital transformation in lending
Artificial Intelligence (AI), machine learning, and blockchain are playing a major role in reshaping MSME loans and financing.
AI and machine learning are used to improve credit assessments by analysing data more accurately and quickly, reducing human errors.
Additionally, blockchain technology enhances security, transparency, and fraud detection, making the entire lending process more reliable.
Final Thoughts
MSME loans play a vital role in strengthening the economic growth of the country. It offers huge potential and opportunities for both lenders and businesses. Despite the challenges, new solutions and technology are creating a more inclusive financial system to support MSMEs.
Discover how Finezza’s advanced lending solutions can simplify MSME financing and drive business growth:
- Loan Management System: Finezza provides a comprehensive tool that allows for efficient management of loans, making the process more flexible and agile.
- Loan Origination System: The robust Loan Origination System helps improve customer experience by streamlining the loan application process.
- Bank Statement Analysis: Finezza uses algorithms to analyse applicants’ financial transactions accurately, reducing the risk of non-performing assets (NPAs).
- Document Identification Framework: This feature enables the real-time extraction and segregation of information from verification documents, simplifying the verification process.
- GST and ITR Verification: The solution includes a framework for verifying GSTIN and ITR data.
Get in touch with us today to learn more!
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