How MSMEs Can Grow by Choosing the Right Lender?

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Muskaan Kapoor

Sep 2, 2023 — 4 min read

Parry Singh, Founder and CEO, Red Fort Capital - How MSMEs Can Grow by Choosing the Right Lender?

This article has been contributed by Mr Parry Singh, Founder and CEO, Red Fort Capital.

The micro, small, and medium-sized enterprises (MSME) sector, which accounts for 30% of India's GDP and employs a staggering 111 million people, is vibrant and rapidly growing. In India, there are reportedly more than 633 lakh MSMEs, of which 324 lakh are located in rural areas and the remaining 309 lakh in urban ones. The industry has made a substantial contribution to the socioeconomic development of the country and complements several important industries. Therefore, it's essential to increase MSMEs' access to financing and investigate cutting-edge alternatives to open funding sources.

Access to credit is essential for their development and expansion. It enables them to invest in modern technologies, expand production capabilities, and meet working capital requirements. Timely financial support empowers MSMEs to navigate challenges and capitalize on opportunities, contributing significantly to the nation's progress. For a number of MSMEs, debt is a necessity for running the business, and choosing the right lender becomes critical.

Informal sources of lending continue to bear a high cost on the bottom line of these businesses with exorbitant interest rates and hidden charges. There are no incentives for the borrowers to make payments timely leading to a lack of credit history.

Key Factors for MSMEs When Selecting a Lender
Maximizing MSME Growth Through Strategic Lending Choices

Key Factors for MSMEs When Selecting a Lender

An MSME can evaluate the following parameters to choose a lender for its business:

Credit History of the Business

An SME should carefully monitor its credit history, as it’s an important parameter for access to credit. A good credit history is a must for cheaper credit from PSBs and Private Banks due to their lower risk appetite. SMEs with poor credit history mostly rely on NBFCs for credit due to their varied risk appetites. Most SMEs in the growth phase of a down phase take credit from NBFCs as there are multiple kinds of products available for various needs of the business.

Use of Funds

There are various new products in the market to cater to the various needs of SMEs. For example, an SME need not take a term loan for its working capital needs, but it can discount the invoices of its major buyers for credit with shorter tenures. This improves cash conversion and helps escape the debt trap. Similarly, if an SME needs to purchase raw materials, it can go for purchase financing. In the end, the SME should carefully judge the debt serviceability and the end use of funds to choose the right product for availing credit. These sources of credit often have to be underwritten differently from a traditional term loan, enabling greater access to credit.

Urgency of Funds

Sometimes SMEs may find themselves in a time crunch when it comes to getting funding. It might be for a new purchase, for servicing a big order or making any other payments. The traditional sources of credit often have delays due to red tape and bureaucracy. In this scenario, SMEs can look for funding from NBFCs that specialize in disbursing credit faster. There are many NBFCs in the market that do this, however, they might charge a premium for the same. One needs to assess the benefits and downsides before making a decision.

Maximizing MSME Growth Through Strategic Lending Choices

Moreover, MSMEs can grow their businesses while keeping the following factors in mind:

Benefits of getting the right lender: Easy access to credit

The right lender can help MSMEs by providing them with formal sources of credit and also building a credit history of the business. A business is rewarded for making timely payments and getting funds at more aggressive costs. And due to standardized methods of underwriting, businesses tend to maintain compliance, which is a crucial part of the business.

Leveraging Government Schemes

For micro-enterprises, the Indian government has launched various funding schemes under ECLGS, CGTMSE, Stand Up India, MSME MDA, etc., which offer credit lines of ₹1 lakh to ₹1 crore collateral-free credit to marginalized MSMEs in rural and underserved areas. The schemes also provide other benefits like lower interest rates and relaxed tenures for women entrepreneurs in these MSMEs. This scheme-based funding is often useful for MSMEs with longer working cycles and low credit demand. Also, it might be cumbersome to apply for and get funding via these schemes since the demand for these is quite high.

Mutual synergies and co-existence of NBFCs and MSMEs

In the past, NBFCs have been particularly active in filling the gap between MSMEs and other financial institutions. Banks have traditionally been reluctant to lend to MSMEs due to their perceived riskiness. However, NBFCs have been more willing to take on this risk and have developed a range of products that are specifically tailored to the needs of MSMEs.

This has made it easier for MSMEs to access the credit they need to grow their businesses. As a result, MSMEs have been able to create jobs, boost exports, and contribute to the overall economic prosperity of India.

Of course, this relationship is one of rewards with its own challenges. NBFCs need to be careful to manage the risk of lending to MSMEs. However, if they are able to do so, the rewards can be great. By working together, NBFCs and MSMEs can build a stronger and more resilient economy for all.