Nearly 40% of lending to MSMEs is through informal channels

Micro, small and medium enterprises (MSMEs) still find access to formal credit a challenge with nearly 40 per cent of lending happening through informal sources, according to a new report by the Omidyar Network and BCG.

The report titled ‘Credit disrupted: Digital MSME lending in India’ estimated that in 2018, the total MSME credit demand will be ₹45 lakh crore, of which ₹25 lakh crore will be met through formal channels with the borrowing done in the entity’s or proprietor’s name. However, as much as ₹20 lakh crore is seen as the unmet credit demand which is financed through informal channels.

“Roughly 40 per cent of MSME lending is done through the informal sector, where interest rates are at least twice as high as in the formal market,” it said, adding that an additional 25 per cent of MSME borrowing is invisible and is through personal proprietor loans.

“We found that urban and rural MSMEs are quite similar in their borrowing behaviour, with nearly identical rates of informal borrowing and bank account registration,” it further said. The findings come at a time when the government is working on special schemes to boost lending to the sector, including a special package announced by Prime Minister Narendra Modi earlier this month to help improve access to credit.

“MSMEs in India continue to struggle with traditional banking challenges that, if addressed by digital lenders, could accelerate both formalisation and digitisation among businesses in this sector,” said the report.

The main challenge

According to the MSMEs surveyed, the challenges faced in access to formal credit included long processing times, lack of transparency in timelines and insufficient loan sizes. “These pain points are substantial enough to compel many MSMEs to continue to seek out informal sources, often at much higher interest rates,” it added.

But, with growing formalisation of the sector due to demonetisation and the introduction of the Goods and Services Tax, maturing ‘India Stack’, along with growing API-based data availability and increasing receptivity, the report said that there is great potential for digital lending. Digital lending to the sector can increase by 10 to 15 times to touch ₹6-7 lakh crore in annual disbursements by 2023. At present, 99 per cent of formal MSME lending is through incumbent banks and NBFCs and most of it is non-digital.

“We could actually see a real opportunity for digital lending to MSMEs. You can do this business at 30- 40 basis points lower than the traditional way of lending to the sector. Not only can one do better quality business with more data, it can also be done in a more efficient manner at a far lower cost,” Roopa Kudva, Partner and Managing Director, Omidyar Network, told BusinessLine .

The report has recommended that digital lenders align themselves with the needs of MSMEs through measures like leveraging supply chain ecosystems and e-commerce platforms and embracing next-generation data analytics.

Significantly, it has suggested revamping the government loan refinancing programmes through SIDBI and MUDRA to include newly-established digital lenders and focus on small, new-to-finance MSMEs. “The current programmes do not serve the riskiest, new-to credit MSMEs segment where support is most needed,” it said.

The report surveyed 1,500 MSME owners with annual business revenue between ₹3 lakh and ₹ 75 crore, held discussions with over 80 MSME owners and interviewed more than 60 digital lenders, intermediaries, ecosystem partners, and other subject-matter experts.