Access to formal credit by MSMEs with the potential to improve economic resilience of businesses and households, especially for underserved and low resource populations

Potential reduction in exploitation of MSMEs by informal sources of credit that charge usurious rates of interest

Potential for established regional players with in-depth knowledge of micro markets, low-cost distribution channels and risk management approaches, to provide access to credit to MSMEs beyond the Tier I cities

Potential for improved data history for MSMEs using alternative data sources such as taxation related information, utility bills payment history, bank account statement analysis in the absence of documented cash flows allowing access to unhindered and unrationed credit and other financial services.

Attrition of consumers between loan cycles may lead them to revert to negative coping mechanisms for their financial needs and reduce the intended impact of the business model.

Despite regulations, if consumer protection measures are not adequately implemented there is a risk of negative outcomes (overindebtedness, multiple lending from different institutions).

Enhancing productivity and economic resilience of micro and small businesses through access to working capital and debt financing for their business needs.

The central bank for India, RBI, launched a National Strategy for Financial Inclusion 2019-2024 with the vision to lay down the strategy for providing access to formal financial services affordably, broadening and deepening financial inclusion, promoting financial literacy and consumer protection. The key pillars of the strategy include universal access to financial services, providing a basic bouquet of financial services, access to livelihood and skill development, financial literacy and education, consumer protection including the establishment of grievance redressal mechanisms, effective coordination between different players in the ecosystem and leveraging technology for sustainable financial inclusion (16.18) In 2014, GoI announced PMJDY as the National Mission for Financial Inclusion to ensure access to financial services, namely, Banking/Savings & Deposit Accounts, Remittance, Credit, Insurance, and Pension in an affordable manner. (16.19) After 2018, once the scheme reached a critical mass with 80% bank account coverage, it was extended with the focus on the opening of accounts shifting from “every household” to “every unbanked adult”. (16.20) GoI launched the Stand Up India scheme in 2016. The Scheme facilitates bank loans between Rs.10 lakh and Rs.1 crore to at least one Scheduled Caste/ Scheduled Tribe borrower and at least one Woman borrower per bank branch for setting up greenfield enterprises and aims to benefit 250,000 borrowers (16.21) A Certified Credit Counsellors (CCC) scheme was launched in 2017 by Small Industries Development Bank of India (SIDBI) for creating a structured mechanism to assist MSMEs in preparing financial plans and project reports to facilitate banks in making informed credit decisions. Web portals like the ‘Udyami Mitra’ and ‘psbloanin59minutes’ have also been launched to make access to credit more seamless for MSMEs. Trade Receivables Discounting System (TReDS) platforms, an institutional mechanism set up to facilitate the trade receivable financing of MSMEs from corporate buyers through multiple financiers, have been set up to address the problem of delayed payments to MSMEs. Pradhan Mantri Mudra Yojana (PMMY), a scheme to finance small business enterprises has been launched in April 2015 whereby lending institutions would finance to micro-entrepreneurs up to ₹10 lakh. Interest subvention scheme has been launched for MSMEs to reduce the cost of borrowings. (16.22) The COVID19 pandemic and its impact on MSMEs led to some critical policy decisions by GoI to boost the sector. A collateral-free, automatic loan with USD 40 billion outlay to benefit 4.5 million MSME units was announced by the Finance Minister in May 2020. Under the provision, business units with more than USD 3.5 million in loan outstanding and with USD 13.5 million turnover will receive credit backed loans of over 4 years tenure with the potential benefit of 12-month moratorium on principal repayment. Also, a subordinate debt fund for stressed MSMEs with an outlay of ~USD 2.7 billion has been announced to benefit 200,000 business units. Under this fund, GoI will also provide ~USD 0.5 billion towards partial credit guarantee to banks who will in turn lend to MSME promoters for equity infusion into their respective enterprises. Finally, a Fund of Funds announced by GoI to infuse ~USD 6.7 billion equity in MSMEs will cater to more than 2.5 million MSMEs with an initial corpus of ~USD 1.3 billion. The fund will help MSMEs to improve their “growth potential and viability” even as they “face a severe shortage of equity”. The fund will enable MSMEs to expand in size and capacity and would also encourage them to list on the main board of the stock exchange. (16.23)

Financial incentives: RBI, in August 2020 announced putting in place an incentive framework for banks to address the regional disparities in the flow of priority sector credit.(16.30) Bank credit to MFIs (NBFC-MFIs, societies, trusts, etc) extended for on-lending to individuals and also to members of SHGs/JLGs is eligible for categorisation as priority sector advance under respective categories viz., Agriculture, Micro, Small and Medium Enterprises, Social Infrastructure and Others (16.31)

Fiscal incentives: GoI slashed corporate tax to 22%, and ended Minimum Alternate Tax (MAT) to revive economy as part of the fourth phase of post-budget economic stimulus measures in September 2019. The base corporate tax for existing companies was reduced to 22% from current 30%; and for new manufacturing firms, incorporated after October 1, 2019, and starting operations before March 31, 2023, to 15% from current 25% (16.33)

Other incentives: As of March 2018, banks can reckon the entire outstanding portfolio to MSMEs, engaged in providing or rendering of services as defined in terms of equipment under MSME Act, 2006, under priority sector without any credit cap (16.32) COVID 19 measures: To improve market access measures for MSMEs, global tenders will be disallowed in government procurement tenders up to ~ US$ 26.67 million. This is aimed at supporting ‘Make in India’ initiative and will increase business for MSMEs (16.34) Special Liquidity Scheme for Non-Banking Finance Companies (NBFCs), Housing Finance Companies (HFCs) and Micro Financial Institutions (MFIs) to be launched with ~ US$ 4 billion where investments will be made through primary and secondary market transactions, in investment grade debt paper of NBFCs/HFCs/MFIs, which will be fully guaranteed by the government. Such a move will supplement other measures by RBI and the government to enhance liquidity in the economy (16.34)

To widen financial inclusion, RBI has issued differentiated banking license viz., Small Finance Banks (SFBs), and Payments Banks in 2015 to expand the scope of banking services for underserved regions and low-income populations. SFBs offer basic banking services such as accepting deposits and lending to unserved and underserved populations, including small businesses, small and marginal farmers, micro and small industries, and the unorganized sector. Payments Banks on the other hand can accept deposits and remittances but cannot lend. The primary target group for Payment Banks is migrant labor and low-income households operating in the unorganized sector. (16.24) Bank loans to MSMEs, for both manufacturing and service sectors, are eligible to be classified under the priority sector lending norms that mandate a total of 40% of Adjusted Net Bank Credit or Credit Equivalent Amount of Off-Balance Sheet Exposure to be dedicated to priority sectors like Agriculture, MSMEs, Education, Housing, social infrastructure, Renewable Energy, among others. To ensure that MSMEs do not remain small and medium units merely to remain eligible for priority sector status, these units will continue to enjoy the priority sector lending status up to three years after they grow out of the MSME category concerned. (16.25) RBI mandates all NBFC-MFIs to become members of recognized Self Regulatory Organizations (SROs) to lay greater responsibility on industry associations and ensure that the financial inclusion mandate set out by the central bank is duly monitored and complied with. (16.26) To solve the problem of delayed payments to MSMEs, RBI laid down guidelines for the operationalization of Trade Receivables Discounting System (TReDS). TReDS was put in place to facilitate Electronic Bill Factoring Exchanges, which could electronically accept and auction MSME bills so that MSMEs could realize their receivables without delay. As of now, only 3 companies have been licensed by RBI to practice TReDS. (16.27) To strengthen the grievance redressal system, among other measures, suitable mechanisms in the form of the Ombudsman Scheme by RBI, IRDAI, and PFRDA have been put in place. Further, SEBI has also instituted a SEBI Complaints Redressal System (SCORES) (16.27) To facilitate capital raising by SMEs and to provide for easier exit options for informed investors, trading of specified securities of small and medium enterprises (SMEs) including start-up companies on Institutional Trading Platform (ITP) in SME Exchanges was launched in 2013 (16.28) In a bid to increase the digitization of MSMEs, key measures taken by the government in the form of Goods and Services Tax (GST) and wider availability of Aadhaar based KYC has provided opportunities to fintech companies to provide data and technology-based services to MSMEs.(16.29)

Investors have been bullish in the BFSI sector. Emerging technologies to improve digital outreach of financial services that promise to substantially reduce operational costs, a strong policy push in the form of universal banking schemes and a largely amenable and well-regulated sector makes for a strong case from an investment point of view. PEs: Warburg Pincus, KKR, Gaja, Gawa, Gojo, Maj Invest, Samara Capital, Capital G. VCs: Accel Partners, A91 Partners, Sequoia Capital, SAIF Partners, SIDBI Venture Capital. Impact Investors: ASPADA, NABARD, Blue Orchard, Lok Capital, Omidyar Network, ACCION- Quona Capital, Caspian, Michael and Susan Dell Foundation, International Finance Corporation (World Bank Group) among others.

Companies: MSME lending: AYE Finance, Magma Fincorp, Kinara Capital, Vivriti Capital, Lendingkart technologies, Finova Capital Pvt. Ltd, Vistaar, Intech, Indify technology, Mintify, Veritas Finance, among others. These companies are focused on lending to MSMEs through technology (Fintech) driven business models with focus on either cluster based financing, Peer to Peer lending or value chain financing. NBFC MFIs: Spandana, Fusion Microfinance, Satya Microfinance, Aarohan, CreditAccess (There are 55 NBFC MFIs in India) (16.35) Small Finance Banks (SFBs): Equitas, Ujjivan, AU Financiers, Suryoday, Janalakshmi, ESAF, Equitas, Utkarsh, North East SFB, Capital. These are differentiated banking entities licensed by RBI to provide banking services to underserved geographies and low income populations. Cooperative Banks: SEWA, Manndeshi.

Pradan, Grameen Foundation, CARE, Manndeshi Foundation, Oxfam, Catholic Relief Services, Rajeev Gandhi Foundation, World Bank, NABARD (National Bank for Agriculture and Rural Development), Regional Rural Banks, SIDBI (Small Industries and Development Bank of India). Besides offering financial services, these organizations are also engaged in offering advisory support to financial service providers including innovations to further financial literacy to last mile consumers.

Traditional microfinance institutions in India already have a nearly ubiquitous presence with 615 of 739 districts being covered by these institutions. However, 210 districts covered by MFIs constitute 80% of the total portfolio outstanding. 11% of the total loan outstanding for these institutions that include Banks, NBFCs, SFBs and not for profit MFIs, is constituted by districts covered under GoI's The Aspirational Districts Programme (16.4) Most of the Fintech companies are headquartered in metro cities and in the absence of ‘feet on the ground’, struggle to run efficient assessments to optimally serve clients at the last mile. Collaborative business models where Fintech companies tie up with NBFCs and Agent Network Management companies (Business Correspondents) to take products/delivery channels to an already captive market is one of the options for exponential scale and depth of outreach. It is important to note the presence of manufacturing and service clusters where financial service providers can focus their attention. The state of Uttar Pradesh has the largest number of estimated MSMEs with a share of 14.2% of the total MSMEs in the country. West Bengal comes as close second with a share of 14%, followed by Tamil Nadu and Maharashtra at 8% each (16.5). Besides the above, RBI has also issued guidelines to financial service providers to prioritise their operations by geography: RBI guidelines for Small Finance Banks: There will not be any restriction in the area of operations of small finance banks; however, preference will be given to those applicants who, in the initial phase, set up the bank in a cluster of under-banked States/districts, such as in the North-East, East and Central regions of the country (16.6) RBI guidelines for NBFC-MFIs: Any new company applying for an NBFC MFI license has to necessarily furnish details about the break up of assets allocated to rural and urban areas. In the same vein, NBFC-MFIs are encouraged to fix their internal exposure limits to avoid any undesirable concentration in specific geographical locations (to avoid overexposure to the same catchment area by several players) (16.7) The general guidance for Banks for lending under the Priority Sector Lending (PSL) norms: The banks are advised to draw up a roadmap for having banking outlets in villages with populations of more than 2000 (in 2009) and less than 2000 (in 2012). Subsequently, the banks are advised to open brick and mortar branches in villages with a population of more than 5000. The banks are also required to prepare Financial Inclusion Plans for a period of 3 years comprising key parameters viz., modes of delivery of financial services, access to Basic Savings Bank Deposit Accounts (BSBDAs), and transactions through the Business Correspondent Channel. (16.8)