The SME CEO Peer Group

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Why MSMEs Are Over Dependent On Unsecured Loans?


Micro, Small and Medium Enterprises (MSMEs) are engines of growth and generate employment in the country. However, this sector is always under discussion mainly because of problems arising out of scarcity of capital. In the recent time, we have been observing a huge surge in unsecured loans. A recent survey has shown that only 22% MSMEs credit demand is met from formal channels like Banks and Financial Institutions and 78% credit demand is met through Alternative Channels (mostly NBFCs) and Self-financing.

Let’s find out why MSMEs aren't able to raise adequate finance from formal channels, the steps taken by Government to improve the flow of credit, and why do they end up relying on unsecured loans.

Major reasons for poor growth of finance through formal channels:

  • Traditional lending process of secured loans: The process being followed by the Banks is traditional (i.e., devoid of pragmatism) in nature. The banks need a large number of papers / documents / information even to entertain the application. In addition to the above, Banks always ask for collaterals to secure the loan amount.
  • Rigorous and extensive process of application, appraisal, sanction & documentation to get a loan: The entire process is very lengthy and involves lots of paper works which MSMEs find very cumbersome. The delay in processing proves to be the cause of concerns for the entrepreneurs which they can ill-afford.
  • Comprehensive credit score: In the absence of proper maintenance of data coupled with poor financials, the Credit Scores of MSMEs remain very subdued and as a result, the Banks do not find the proposal worth considering.
  • Unforeseen delay: Apart from normal delay in processing the proposal, there is always a threat of unforeseen delay due to change of official(s), change in policy of the lending institution, etc.
  • Long turn-around time: From the date of submission of application to disbursement of loan, the journey happens to be very long which at times makes the unit sick even before the operations begin. There is practically no hurry / urgency to dispose the loan proposals even though every Bank has fixed timelines for this.
  • Lackadaisical attitude: MSMEs are usually susceptible to changes in working cycle, government policies, environmental change, etc. They deserve empathy and careful handling. However, Banks normally do not bother about these aspects.

Steps taken by RBI & Government to address the problems: 

To channelise credit flow to the MSMEs and address the finance gap, the Reserve Bank of India (RBI) has mandated Banks specific targets for lending to these businesses as part of the Priority Sector Lending norms. This is certainly a big step as far as the MSME segment is concerned and is likely to go a long way to resolve the access to finance problems faced by them from a policy perspective. 

Additionally, Reserve Bank of India (RBI) proposed setting up of credit rating agencies. In pursuance with this suggestion, SME Rating Agency (SMERA) was incorporated by SIDBI, Banks and Dun & Bradstreet. They have introduced various rating products to evaluate and rate MSMEs, helping them to access Bank financing easily and at better terms.

To address and resolve concerns related to lack of adequate collaterals, Banks are encouraged to offer collateral free loans, wherein Credit Guarantee Fund Trust for Micro and Small Industries (CGTMSE) offers credit guarantee cover to Member Lending Institutions (MLIs), up to 75% on the default amount. This is a boon for micro units and start-ups, who can raise initial funding for CAPEX (Capital Expenditure) without having to worry about collaterals.

Pradhan Mantri Mudra Loan Yojana, an ambitious loan scheme for MSMEs, aims to “fund the unfunded”. In other words, this scheme is expected to ensure adequate flow of credit in the MSME sector. Increased and easy credit will help these businesses to expand, hire more people, and become larger contributor to overall economic growth. 

Incidentally, prior to launching this scheme, a public sector financial institution, Micro Units Development and Refinance Agency Bank (or ‘MUDRA Bank’) was launched to provide loans at low rates to MFIs and NBFCs which, in turn, provide loans to MSME.

Despite all the efforts / steps taken by RBI and Government, there has been a tremendous increase in Unsecured loans over the years. To be specific, Unsecured loans grew four times  between 2015 and 2018 faster than Bank credit with 27% annual CAGR. Here are the major factors which have been playing a big boost to unsecured loans by NBFCs.

  • New age lending platforms
  • Complete online experience
  • Discretionary spending
  • Increased availability of customer data
  • Digital innovation
  • No collateral requirement
  • Simple and easy application processes
  • Quicker disbursements
  • Flexibility
  • Transparency
  • Customised solution

It will not be out of place to mention that there are established methodologies used by niche NBFCs such as sectoral value chain and cash flow scenarios, small business and household cash flow, sensitivity analysis, small business owners network profiling and psychometric assessment tools to understand the willingness of small business owners to repay the loan. 

It is apparent that Government, RBI, Banks, NBFCs and MFIs have been working together in ensuring increased flow of credit to the MSME sector. However, there is no denying the fact that a lot more needs to be done, in providing easy credit to MSME for their healthy growth.


Pulak Kumar Sinha is a retd. General Manager at State Bank of India. He is a Certified Associate of Indian Institute of Bankers and has a P.G. Diploma in Management from All India Management Association (AIMA). His specialised areas are Credit and General Banking. He was also a Chairperson of Reserve Bank of India Working Group on Evaluation of Feasibility of Aadhaar based Biometric Authentication as Additional factor of Authentication for card related transactions and other issues.


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