By Jitendra Tanwar
Micro, Small, and Medium-Sized Enterprises (MSMEs) in India now bank heavily on Non-Banking Financial Companies (NBFCs) for financing. With over 110 million employees and more than 30% of the nation’s GDP, the MSME sector plays an essential part in both social and economic advancement. However, the industry confronts obstacles like restricted finance availability, intricate regulatory mandates, and a scarcity of skilled workforce. By helping MSMEs satisfy their financing needs, NBFCs have become an essential partner in filling these gaps.
NBFCs Address the Credit Gap
In India, MSMEs frequently struggle to obtain formal finance, and many rely on expensive informal financing. The Reserve Bank of India (RBI) claims that NBFCs have expanded their lending to MSMEs by providing more flexible and easily accessible options than traditional banks. NBFCs reported a 42.4% year-over-year increase in lending to MSMEs in 2022–2023, while banks recorded a 12.4% increase. This indicates how they are increasingly helping small businesses.
The total debt demand in the MSME sector is estimated at ₹106.11 lakh crore, of which only ₹28 lakh crore is supplied through formal channels, leaving a significant credit gap of ₹28.24 lakh crore. As the economy formalizes, this gap is expected to widen. NBFCs are well-placed to help address this issue by reaching underserved areas and offering financing tailored to the needs of MSMEs.
Advantages of NBFCs in MSME Lending
NBFCs offer several advantages when it comes to supporting MSMEs with their financial needs. One key benefit is the flexibility they provide in their lending solutions. Unlike traditional banks, which often have strict lending criteria, NBFCs are more adaptable. They offer products like short-term loans, working capital loans, and asset-based financing, allowing small businesses to access the funds they need for specific purposes, such as purchasing equipment or expanding operations.
Another significant advantage is the localized focus of many NBFCs. These institutions often concentrate their efforts on Tier 2, Tier 3, and rural markets—areas that are underserved by traditional banks. By focusing on these regions, NBFCs can develop stronger relationships with local business owners and gain a better understanding of their unique financial needs. This approach helps stimulate economic growth in areas that may have limited access to formal financing options.
Additionally, NBFCs have embraced technology to streamline their lending processes. Tools like India Stack make it easier for MSMEs to access credit by simplifying identity verification and loan approvals. The use of data analytics and alternative credit assessments allows NBFCs to serve businesses that may not have formal credit histories, improving efficiency and making credit more accessible to a broader range of MSMEs. This technological integration helps ensure that small businesses have the resources they need to grow and succeed.
Impact on MSME Growth
One of the most important things that allows MSMEs to invest in their growth is finance availability. Businesses could look into options like growing their manufacturing capacity, improving their technology, or entering new markets with the right financing. In order for MSMEs to take advantage of growth opportunities, NBFCs are essential in supplying the timely funding required for these projects.
As MSMEs grow, they contribute significantly to job creation, especially within local communities. Government data shows that MSMEs in India have generated over 20 crore jobs. The role of NBFCs in supporting these businesses is crucial, as they provide the necessary financing to facilitate this job creation. Additionally, by fostering growth in local businesses, NBFCs help reduce the migration from rural to urban areas by offering employment opportunities closer to home.
NBFCs also contribute to balanced regional development by focusing on smaller towns and rural areas. Their efforts help spread economic activity beyond major urban centers, promoting growth in less developed regions. This localized support reduces the financial exclusion faced by businesses in these areas, ensuring more equitable development across the country.
Collaborative Models: Co-Lending with Banks
To expand their reach, many NBFCs have partnered with banks in co-lending arrangements. These partnerships combine the local expertise and operational efficiency of NBFCs with the low-cost capital of banks. Co-lending helps both institutions share risks while increasing the availability of credit for MSMEs, emerging as a practical solution to bridge the financial gap.
Challenges in MSME Lending
Despite NBFCs’ growing involvement in MSME financing, a number of obstacles still exist. Liquidity limitations are a major problem since NBFCs frequently depend on borrowing to finance their operations, which leaves them susceptible to changes in the market. Because the complicated processes might increase the operating cost on NBFCs, regulatory compliance is another difficulty. Furthermore, credit risk is still an issue, especially since many MSMEs do not have official credit histories, which increases the chance of default.
Problems like inadequate collateral, a lack of documentation, and erratic cash flows still make it challenging for MSMEs to obtain finance. To overcome these obstacles, the lending industry must continue to innovate and implement rules that lower risks and increase small business access to financing.
NBFCs are essential in helping India’s MSMEs access the credit needed for growth. By offering flexible financing options and focusing on underserved areas, they support business expansion and job creation. Despite some challenges, the increasing collaboration between NBFCs, banks, and fintech companies has the potential to strengthen the financial system and improve access to credit for MSMEs across the country.
About the Author: Jitendra Tanwar, Managing Director & CEO of Namdev Finvest
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