7 Things You Should Know About MSME Financing

Micro, small and medium-sized enterprises (MSMEs) are largely dependent on banks and non-banking finance companies (NBFCs) for external funding. The success of this largely unorganized sector of the Indian economy is to a great extent influenced by the credit they receive from these lenders.

Still, almost 80% of MSMEs in India have no access to formal credit. Although some MSMEs have benefitted from alternative sources of capital like equity finance and angel funding, yet that percentage is negligible.

MSME Financing: The Challenges

A study of the banking system reveals an interesting relationship between bank size and customer. It shows a low propensity of conventional banks and NBFCs to aid small and medium businesses.

In India, the main reasons for this are that most MSMEs are either too vulnerable and dependent on seasonal business cycles or do not maintain a consolidated record of tax returns, profit and loss statements, and other financial transactions.

The complexities and the time involved in the loan application process as well as the banks’ fondness for substantial physical assets also put many MSMEs at a disadvantage. Low levels of bank penetration in remote parts of the country and risk aversion stretch the credit gap even wider.

MSME Loans

MSME loans can be availed by business owners or entrepreneurs for their business needs. MSMEs can use these loans for buying machinery, consolidation of debts, managing monthly operational expenditures, etc.

Here are seven things about MSME financing that entrepreneurs and business owners should be aware of:

1. Eligibility Criteria:

MSMEs, limited companies, sole proprietorships and partnership firms in the trading, service and manufacturing sectors who have a decent repayment history, a good credit score of at least 750 and a minimum business vintage of one to two years are eligible for MSME loans.

2. Lack Of Collateral:

MSME loans are both secured and unsecured. Banks are majorly concerned about their own interests. They consider businesses with erratic cash flow and poor operating history as risky ventures and usually tend to disassociate themselves with such dealings. Hence, they prefer to offer secured loans. On the other hand, small business owners usually opt for unsecured business loans from lenders where they do not have to worry about providing collateral. There are many banks and NBFCs that offer collateral-free MSME financing options of up to a few crore rupees, depending on their annual turnover.

3. Interest Rate:

The interest rate on MSME financing varies from lender to the lender. Some factors that determine the business loan interest rate are loan amount, repayment tenure, business annual turnover, company’s credit rating, and applicant’s income and credit profile, repayment capability, etc.

Maintaining a good credit score helps in the loan approval process and in negotiating a lower interest rate. Businesses that have MSME registration get an additional benefit of 1% exemption on any interest rates that banks charge on overdrafts.

4. Digital Lending:

The integration of technology into the banking sector has led to a surge in digital lending, especially after the Covid-19 pandemic. Business owners no longer have to visit the bank’s branch, stand in a queue to submit documents and wait for months to acquire funds for their businesses.

Online MSME financing solutions, made possible through digital lending platforms, can be availed anytime and from anywhere for faster and smoother credit.

5. Repayment Tenure:

Depending on the loan amount sanctioned by the lender, the tenure of an MSME loan can be for a maximum period of 15 years. However, collateral-free business loans are usually short-term loans, with a repayment tenure of a maximum five years.

6. Documents Required:

The documents required by banks and NBFCs usually vary. However, some common documents required for loan approval are a duly filled application form along with passport-sized photographs, KYC documents of applicant and co-applicants, address proof (both of residence and business), bank statement (last 6-12 months), Business Establishment Certificate or proof of registration of business.

7. Government Schemes:

In 2020, the government of India announced a new definition of MSMEs to strengthen the growth of this sector.

In addition, the government has announced a host of schemes like the MUDRA Loan, Credit Guarantee Funds Trust for Micro and Small Enterprises (CGTMSE), National Small Industries Corporation (NSIC) Subsidy, etc. All these schemes, initiated by the Ministry of MSME, are offered through various banks and NBFCs.

Conclusion

There is a huge credit gap in the MSME financing sector. Most larger banks prefer lending to big and well-established businesses. On the other hand, most MSMEs face challenges in terms of education and financial literacy.

Fulfilling the credit requirements of the MSME sector is the only solution available for the overall development of the Indian economy. This is exactly where alternative digital lending solutions have proved to be beneficial.

IIFL Finance, a leading market player in financial services, offers instant unsecured business loans of up to Rs 30 lakh for a five-year tenor. IIFL Finance also offers secured business loans of up to Rs 10 crore for as long as 10 years.

Since the company’s own evolution from an entrepreneurial startup to a diversified financial services group, adapting to the changing business environment has always been its focus. Hence, it offers 100% digital loan application services for a timely and hassle-free loan disbursal.