Credit to micro and small businesses is slowing down

The credit flow to micro and small businesses is slowing down over a sustained period of time, however credit flow to medium enterprises is on track.
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One of the key strategies that the government employed to mitigate the onslaught of the pandemic and stimulate the economy was by enabling credit access and easing the working capital gap for Micro, Small and Medium Enterprises (MSMEs). Accordingly, the Aatma Nirbhar Bharat Abhiyaan was launched in May 2020 and included measures to ease the liquidity crunch for MSMEs and improve credit access for Non-Banking Financial Company  (NBFCs) through policies such as the Emergency Credit Line Guarantee Scheme (ECGLS) and Credit Guarantee Scheme for Subordinate Debt. 

The total credit extended by scheduled commercial banks (SCBs) to MSMEs grew by 7.66% between March 2020 and March 2021, according to the RBI’s sectoral deployment of bank credit data. 

Credit to medium enterprises grew by 47.81% between 2019-2020, but credit to micro and small enterprises grew only by 2.48%. In absolute terms, micro and small enterprises contributed 76.7% to the growth of total credit to MSMEs between 2019 and 2020, compared to 23.3% for medium enterprises. Between 2020-2021, this pattern reversed as medium enterprises got 71.3% of the total credit compared to 28.7% for micro and small enterprises. This suggests a possible slowdown of the expansion of credit to the micro and small enterprises 

study on the impact on ECGLS by the National Institute of Bank Management in Pune found that there was inequality in the disbursed amounts, with the majority of enterprises getting credit with low ticket sizes. Estimates suggest 80% of the borrowers got 30% of the disbursed amount, which roughly translates to most of this credit that a small proportion of the borrowers availed. We wanted to delve deeper into borrowing patterns of MSMEs and estimate the impact of liquidity easing measures on the MSME sector. We used the ProwessIQ database to examine short-term borrowings by MSMEs. We start off by analysing the extent of participation by MSMEs in availing credit from formal sources. We then understand the borrowing trends of MSMEs which do avail credit from formal institutions. 

Sources of credit

Enterprise size and the access to formal credit continue to share an inverse relationship. In 2016-2020, formal credit constituted 30% of microenterprise borrowing, 40% for small enterprises and around 60% for medium enterprises. Regarding the number of enterprises availing formal credit, approximately 55% of microenterprises in the sample availed formal finance compared to around 80% for small enterprises and 85% for medium enterprises. This indicates the inverse relationship but also points towards the fact that enterprises of all sizes borrow heavily from sources other than banks and financial institutions, and the problem is more severe microenterprises with low participation in the formal credit market. Although this inverse relationship is documented, the key takeaway is the low shares of formal borrowing and participation rates, especially for microenterprises. Numbers are significantly lower than reported because of the nature of the companies included in ProwessIQ. 

The breadth and depth of formal credit

The borrowings by MSMEs from formal institutions has increased between 2016 and 2020. Average borrowings from formal sources by microenterprises increased by 96% between 2016-2020, while formal credit to small and medium enterprises increased by 31% and 12%, respectively. This increase in the average borrowings was driven by an increase in total borrowings, which increased by 126% for microenterprises. Still, the number of enterprises availing formal credit stayed almost the same through the five years. This leads to the possibility that a significant part of the expansion in credit has accrued to enterprises that were already in the fold of formal finance. On the other hand, as credit to micro and small enterprises expanded, participation of microenterprises continued to stay low. 

SIDBI’s MSME Pulse concurs the analysis, where the index for origination for new-to-bank enterprises has stayed below 100 and seen negative y-o-y growth for most of 2020. However, the silver lining here is that the latest report’s index for new-to-bank enterprises crossed pre-pandemic levels. 

NBFCs play a significant role in ensuring credit supply to populations underserved by banks, such as microenterprises, even among formal financial institutions. NBFC’s saw the credit extended by SCBs declined by 4.67% between July 2021 and March 2020. The drastic change can be attributed to a 5.62% dip in credit extended between March and July 2021. 

A report by Omidyar Network concurs backs the finding that these smaller non-banks found it challenging to raise money under schemes like ECLGS and therefore were unable to pass it on to the enterprises. 

Microenterprises constitute about 99% of the MSMEs in India. Therefore, formal credit ought to have breadth and depth in order to unlock growth for the MSMEs and the economy at large.

Authored by Prithviraj Dasgupta consultant with the Global Alliance for Mass Entrepreneurship (GAME) and Kinjal Sampat who leads the functions of Research, monitoring and Evaluation at GAME.