The micro, small and medium enterprises (MSME) sector was severely hit by the COVID-19 pandemic and the subsequent lockdown. Movement restrictions and labour shortages, even after the unlock, resulted in production delays (due to upended supply chains and fewer workers) and delays in the transport of finished goods (due to cross-district and -state travel restrictions. The liquidity crisis in the larger economy only compounded the existing liquidity shortage in the MSME sector.

While the RBI and the government came out with specific guidelines and packages to ease the liquidity pressures, most banks remained sceptical of extending credit to MSMEs. The Reserve Bank’s guidelines are not directives, and the banks are not bound to follow them. Therefore, they merely use their discretion while lending to MSMEs.

 Although they are traditionally perceived as a high-risk sector for lending institutions, MSMEs contribute nearly 30 per cent to India’s GDP and employ over 11 million people across the country. A crisis in the MSME sector will send shockwaves through the entire socio-economic system.

Financial institutions and MSME lending

While banks’ approach to credit has primarily been relationship-based or predicated on documentation, many of the micro and small businesses in India typically lack the documentation required to secure the desired credit. Additionally, since MSMEs rarely publicly trade equity or issue debt securities, there is very little public data available on their performance. All this limits the amount of credit that banks extend to the SME sector.

Access to fast, adequate working capital credit remains the chief concern for MSMEs. While banks have been disbursing funds under the Emergency Credit Line Guarantee Scheme (ECLGS), they are facing increasing competition from alternative lending institutions such as online peer-to-peer lenders, payment companies, online balance sheet lenders, NBFCs, and lender-agnostic marketplaces. Many of these FIs are leveraging their sector expertise as well as digital technology to process applications and disburse funds quickly to MSMEs.

Post-COVID MSME lending

With so many options, MSMEs in the post-COVID world should choose their lender of preference depending on the loan application requirements and disbursal time, among other factors. The pandemic has created a new normal of social distancing and remote working, meaning that digital processes and operations will increasingly become the order of the day. MSMEs can opt for digital lending partners having sector expertise and a willingness to engage with them on a trust basis.

MSMEs should also take advantage of the government loan guarantee schemes under the Atmanirbhar Bharat Abhiyaan. They must tailor their loan application and documents to urge banks to consider them under the same.

Micro firms should also consider microfinance companies and institutions for their requirements, rather than bank loans. Micro loans can be paid back more easily, thus extending the firm’s credit line and allowing them to operate with low risks.

Banks and other lending institutions should proactively engage with MSMEs early. As the credit requirements for each business segment varies considerably, banks should view MSME loan applications under a segmented lens, rather than a more generic MSME one. This will help them get a better idea of the risks and returns involved in approving the application.

In conclusion, the COVID-19 pandemic has brought enormous transformations to the MSME sector, and the BFSI sector should evaluate and engage with them on more proactive and supportive terms than heretofore.

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