With about 64 million MSMEs in India overall, the total funding requirement for the sector is projected to reach Rs 134.40 lakh crore. Of this, total debt demand is estimated at Rs 106.11 lakh crore, of which Rs 56.24 lakh crore or 53% is anticipated to be the potential market size addressable through formal funding sources such as banks and NBFCs, according to a CareEdge report. Considering the existing supply of Rs 280 lakh crore (based on FY24 projections), the credit gap is estimated at approximately Rs 28.24 lakh crore. Moreover, as the economy formalizes, unaddressed demand currently met through informal funding sources is anticipated to transition towards institutionalised channels over the long term, resulting in a potential credit gap of ₹78.13 lakh crore.Non-banking financial companies (NBFCs) are emerging as an important player in MSME lending exhibiting 3x y-o-y growth in FY23, surpassing both public sector banks (PSUs) and private sector banks (PVBs). This growth trajectory is expected to continue, with NBFCs, private sector banks and public sector banks projected to achieve growth rates of 25%, 15%, and 10%, respectively, in FY24 and FY25.
The overall asset quality within the MSME portfolio has steadily improved across all categories of lenders and all sub-segments of MSMEs.
Profitability metrics for NBFCs with a focus on small ticket-size MSMEs are expected to moderate due to compression in Net Interest Margins (NIMs) and heightened credit costs stemming from new-to-credit (NTC) clients and predominantly unsecured microloans.
Fight for the pie
Lending to MSMEs has garnered increasing attention not only from banks but also NBFCs. Over the past five fiscal years, Private sector banks have demonstrated a compounded annual growth rate (CAGR) of approximately 18%, whereas PSBs have recorded a CAGR of about 5%. The pursuit of better yields and improving asset quality have led to PVBs increasing their focus on MSME lending, with PSBs ceding their share to PVBs.
NBFCs have reported approximately 31% CAGR growth in the last three fiscals. Notably, these entities have seen a substantial percentage increase in their share of MSME lending, also reflected in their loan book growth compared to banks, with NBFCs reporting more than 3x growth in FY23 y-o-y compared to both PSBs and PVBs.
The hurdles
The MSME sector has encountered significant challenges due to events such as demonetisation, COVID-19, and the Goods and Services Tax (GST) implementation. Despite these obstacles, MSMEs are increasingly adopting digital channels, which in turn facilitates smoother identity verification and underwriting processes for lenders. However, MSME lending still faces notable barriers, including a lack of comprehensive data, collateral, documentation, and the absence of formal credit histories. “Information” emerging as the new collateral, facilitated by “India Stack” and other digital solutions, thereby improving access to funds for MSMEs to meet their various financial requirements.
