Top 5 challenges for MSME business loans

MSME companies are what makes the Indian economy what it is. However, even though they’re everywhere and contribute immensely to GDP and employment, growth in MSMEs are hard to come around. Business loans are usually not given out to smaller companies to fund their growth and even if they are, they’re often not affordable.

In this article, we’ve compiled the top 5 challenges that MSMEs in India face when applying and sourcing business loans, how they can be solved, and what these issues broadly point towards.

Biggest challenges for MSME loans in India

Here are the top 5 challenges in no particular order:

Limited trust amongst lenders

From the perspective of a lender, an MSME is a risky investment. This is because unlike publicly-traded or large private companies, MSMEs lack a credible track record in their area of operation, they’re small and hence have a lot of management risk, and usually demand less money than bigger corporations.

This often leads to banks and other credit organisations imposing stricter regulations on smaller companies, making application processes harder and more complex, and imposing tough approval rates. The case is even tougher for startups and other tech-driven innovative ventures.

The solution:

• Establishment of a credit information system that can provide lenders with more information about the financial health of an MSME rather than just sales and cash flows. This could help legitimate businesses with strong models get the funding they need to grow.
• Government guarantees can also help mitigate lender risk by securing riskier loans with insurance funds.

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Lack of collateral

Traditional lenders heavily rely on collateral, often land or property, which many MSMEs, especially new businesses, lack access to. Most MSMEs usually take loans to expand operations, which are essentially those assets that are traditionally used as collateral. This creates a vicious cycle, hindering their ability to expand and build assets, further limiting their loan eligibility.

The solution:

• Collateral alternatives in the form of receivables, inventory, or machinery financing can open doors for businesses that lack traditional assets.
• Non-banking financial institutions (NBFCs) and online lenders are often more flexible with collateral requirements, catering to the diverse needs of MSMEs. These institutions could be incentivised to focus more on MSME fulfilment.

Financial literacy

Lots of MSME owners lack the financial literacy required to search for favourable rates, pay their EMIs on time, and use the borrowed capital to good use. This often leads to poor financial management, difficulty in preparing loan applications, and inability to choose the most suitable loan products. It is these people who then fall into debt traps leading to business failure.

The solution:

• Digital financial tools can empower MSMEs to keep track of cash flow, use modern accounting practices, and keep financial statements intact to make sure that their books are in order when they apply for loans.
• Financial advisors targeted towards MSMEs can also help people manage their finances, take loans to expand, and use the money judiciously.

Also read: Interest rate risk – Meaning and risk management strategies.

Adoption of modern technology

A large portion of MSMEs are concentrated in rural areas of the country where bookkeeping and accounting are often done on paper, manually. This makes it difficult for lenders to analyse the credibility of these numbers, decreasing the chances of a loan getting approved. The adoption of modern tech can reduce administrative costs for both parties and make financial data transparent.

The solution:

• Fintech integration in the form of easy-to-use mobile apps can facilitate seamless data sharing between clients and banks. This could lead to automated loan assessments, faster approvals, and reduced overhead costs.
• Cloud based solutions could also help rural farmers access modern banking facilities in the city, leading them to access reduced rates in a more competitive environment.

Regulation

Getting a loan approved is no easy task for a small business, and the last thing they need is governmental and municipal regulation. The documentation and complex regulatory procedures can be overwhelming for MSMEs, especially those which don’t have experience with the system. This pushes them away from formal financing towards other money lenders, who are often more expensive and hostile.

The solution:

• Streamlined processes for loan applications, disbursement of funds, and document submission can often reduce processing time both for borrowers and for banks.
• Reforms in regulation could also help in the long term, not only boosting confidence for these borrowers, but also generating employment and increasing spending.

Also read: PMRY: Guide to the central government loan scheme for unemployed youth

Conclusion

MSMEs are businesses too, and just like any other businesses, they too need capital to expand. If the financing environment for MSMEs becomes easier, the economy stands to improve from better innovation, high employment, and greater contribution to the GDP.