April 6, 2020
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Improving Financing Options for MSME’S – V.P. Nandakumar

VP NandakumarThe micro, small and medium enterprises (MSME) sector makes significant contributions to our economy. It consists of about 26 million enterprises which account for 45 percent of India’s manufacturing output and 40 percent of its exports. The MSME sector provides jobs to 69 million people in such activities as readymade garments, leather, gems and jewellery, light engineering and handicrafts. About 50 percent of MSMEs are owned by disadvantaged sections of society.

As per law, there are two classes of MSMEs, manufacturing enterprises and service enterprises. At the higher end (i.e. for medium enterprises), investment in plant and machinery, equipment etc. should not exceed Rs.10 crore for manufacturing enterprises and Rs.5 crore for service enterprises.

Notwithstanding the valuable contributions, only about 5 percent of MSMEs has access to capital from the organised financial sector according to statistics compiled by the Ministry of MSME. Given the perception of higher risk, it’s no surprise that banks have generally hesitated to lend to the sector. The attitude of indifference persists with the government departments, other financial institutions and the corporate sector. Consequently, the MSME sector faces many hurdles in its growth path and finds it difficult to maintain its competitiveness in the domestic and the export markets.


SMEs face many problems besides the lack of access to bank finance. They have limited capital and knowledge, they don’t have access to suitable technology, their production capacity is low and their marketing strategy may be ineffective.  They face constraints of capital when it comes to modernisation, expansion or identification of new and promising markets. Their day-to-day operations are affected by the non availability of skilled labour at affordable cost. Lacking the clout of the large scale enterprises, they are further handicapped when it comes to follow up with various government agencies to secure basic infrastructure facilities or resolve other pressing issues.

Because banks have generally been cautious about lending to MSMEs, especially to the micro enterprise segment, NBFCs have emerged as an important source of finance. Until fairly recently, money lent by banks to the NBFCs for onward lending to the MSME sector was classified as priority sector lending (PSL). Banks were allowed to include the amount in their commitment to lend up to 40 percent of their total loans to national priorities like agriculture, MSMEs, exports etc. as mandated by the RBI.

In 2011, the rules were changed and banks are no more allowed to route their priority sector commitments through the NBFCs. Instead, they are required to lend directly. A practical consequence of the change is that banks now have less incentive to lend to the NBFCs and this, in turn, has negatively affected the flow of credit to the MSMEs. The paradox is that a measure that was meant to compel banks to lend directly to MSMEs and thereby put more money into their hands has, in practice, led to the opposite. NBFCs have been forced to cut down on their lending to MSMEs while banks are yet to gear up to the challenge.

A recent newspaper report mentions says more than two lakh MSME units are considered sick. Around 29,000 units are being added to the sick list every year. It has also led to the blocking of an amount of Rs.7,000 crore in outstanding bank credit.

Action points

From the point of view of the MSMEs, there is a crying need for a more liberalized credit dispensation from the commercial bank as credit penetration in this sector is still low. One reason is insufficient credit information on MSMEs and the constraints in analysis faced by bank officials. In order to instil more confidence in bank officials and thereby make bank funding easier, we require more numbers of credit rating agencies specialising in MSME ratings. The SME Rating Agency of India (SMERA) launched in 2005 by SIDBI (in association with other institutions) is a welcome initiative but we need more of such agencies. We need greater awareness among MSMEs and bank officials of the existence of such ratings.

We should also consider setting up more specialized lending institutions on the lines of SIDBI, NHB etc. We must adopt simple procedures for raising capital or when going in for equity listing. Finally, more stock exchanges have to be established that would list MSME shares along with a separate capital market regulator overseeing separate regulations that would make it easier for MSMEs to raise equity.

No doubt there is a long way to go but keeping in mind the transformation that a thriving MSME sector can bring about, it is imperative that the efforts begin now.

V.P. Nandakumar is MD & CEO of Manappuram Finance Ltd.

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