Abstract:
Micro, Small and Medium enterprises (MSMEs), have played a significant role in India’s industrial and manufacturing development by contributing to GDP, exports and the level of employment in the country. However, its growth is still restricted by the lack of credit availability and inefficiencies in the formal lending structure. This article explores the gap between the demand and supply of credit and problems in credit allocation faced by the MSMEs. It further evaluates government-led initiatives such as the credit guarantee mechanism, cash flow-based lending (CFBL) and the Unified Lending Interface (ULI). Peer comparison with other countries reveals that the country’s credit structure requires systematic reforms.
Introduction:
In the heart of India’s manufacturing powerhouse—the Micro, Small, and Medium Enterprises (MSME) sector—lies a paradox of promises by the government and perils from the financial institutions. Employing over 110 million people and contributing nearly 30% to the nation’s GDP and 45% of the nation’s exports (MSME Annual Report (2017), WBG-Intellecap Analysis) , MSMEs form the foundations of “Make in India” by driving the
future of manufacturing with exports and resilient supply chains. Yet, as of FY2025, this vital sector is gasping under a severe credit bottleneck, potentially threatening to derail the country’s ambitions for a $5 trillion economy by 2027. With manufacturing MSMEs spanning auto components, textiles, food processing, and metals, accounting for over 40% of the sector output, the ripple effects of funding shortfalls are not just financial; they are existential,
fueling a perceptible slowdown in industrial momentum as many large-scale enterprises depend on MSMEs for the supply of raw material.
As of March 2025, total outstanding formal credit to the sector stands at ₹35.2 lakh crore (₹31.3 lakh crore from scheduled commercial banks alone across 2.45 crore active loan accounts, with the rest from NBFCs and SFBs), with fresh disbursements of ₹2.5 lakh crore in FY25, a respectable 13% y-o-y growth, largely driven by public-sector banks and the lingering impact of ECLGS – emergency credit provided to businesses during the pandemic.
However, this aggregate growth conceals a sharp bias towards the medium enterprises, which captured the bulk, while micro enterprises, which constitute over 92% of total loan accounts but only 24% of outstanding value, continue to receive disproportionately low formal credit and are still outpacing medium-scale enterprises by 4-6 percentage points in y-o-y terms.
Independent studies (by IFC-Intellecap, SIDBI-TransUnion CIBIL, and SIDBI-Crisil 2025) estimate the total debt demand of Indian MSMEs at ₹90-95 lakh crore, with a massive finance gap of ₹25-30 lakh crore (22-25% of total requirement). These studies did not account for microenterprises whose operations are not deemed to be financially viable for institutional credit and are forced to rely on much costlier and riskier non-institutional credit – limiting their scale of operations, even potentially threatening their existence in many cases. For the remaining manufacturing SMEs alone, the unmet need is close to 20% of their total demand and rises to 30-35% for micro-manufacturing units in textiles, metals, and garments. In the manufacturing sector, SIDBI reports, “While access to finance has improved for some, concerns about adequacy and availability persist for a significant portion of manufacturers.”
Risk Mitigation:
Mostly formal sources of credit like commercial banks, microfinance institutions, and NBFCs are hesitant when it comes to lending to MSMEs, especially the micro-units, primarily due to the high perceived risk by these. Only 16% of micro-units are able to use formal sources of
credit, and the other 84% depend on informal and own funds. There are various reasons for it, like low technology adoption by these micro-units as compared to larger enterprises, limiting their growth in the future. Most of the microunits are sole proprietorships; therefore, they form a part of the unorganised sector and thus have low documentation of their past activities, like GST reports and financial statements, which creates information asymmetry (borrowers have better information about their creditworthiness than the lenders), which makes computing risk a burdensome task for the lenders, abating their trust in smaller enterprises. Further, smaller enterprises tend to have limited securities to pledge against the loan amount as collateral, which furthers the risk for banks. Furthermore, the opportunity cost incurred by lending to smaller enterprises is too high, as the same funds could be directed towards larger enterprises – with easier credit assessment and at a lower risk.
The government has tried to come up with measures to reduce this risk so that various sources of credit don’t feel hesitant while lending to Indian MSMEs. Udyam Registration is a government platform where MSMEs can register themselves based on GST and PAN numbers. No documents are required to be uploaded, as it uses GST & income tax databases to auto-fetch turnover & investment. It helps the MSMEs get credit in a simplified
manner, as the banks get transparent data of their clients, thus reducing asymmetric knowledge and enabling data-based credit assessment. Some banks have made the Udyam Registration Number (URN) mandatory for providing credit.
The government has introduced the Government e-Marketplace, where MSMEs can directly sell their goods to government departments. Over 20 lakh MSMEs have been registered on this platform. In addition to providing the benefits offered by Udyam Registration, it also ensures a stable customer base (government) and a transparent transaction history which banks have access to.
The government introduced the scheme of CGSTSME, wherein it would provide a guarantee of up to 75-85% of the amount of the loan sanctioned to micro & small enterprises registered under this scheme, thus reducing the risk of banks and increasing their willingness to lend.
The government introduced the MSME Samadhan Portal, wherein it facilitates pending payments of any government department or large companies beyond 45 days through MSEFC (Micro & Small Enterprises Facilitation Councils). This reduces the stress of working capital requirements and enhances creditworthiness through predictable cash flow.
The Government of India Bronze/Silver/Gold ZED (Zero Defect Zero Effect) certificates are based on their quality, productivity, sustainability, etc. This increases lender confidence, as lenders consider enterprises with such ZED certificates to be less risky, as these have strong quality and compliance systems. This enhances the reputation and survival probability of firms.
The government recommends maintaining online books like Tally Online or Zoho Books, which would reduce chances of financial fraud and help in better credit assessment by banks. They also contribute to supporting government risk mitigation schemes like Udyam Onboarding, CGTSME underwriting, and GeM seller verification.
Potential Implications of this Bottleneck:
Restricted credit forces small enterprises to turn to informal sources, infamous for charging sky-high interest rates (estimated at 18-36% p.a.), as they offer high speed and flexibility ,with 8% overall for MSMEs and 12% accounting for micro alone. Costlier credit squeezes working-capital cycles and delays capacity expansion and technology adoption, which combined directly contribute to the ongoing slowdown in manufacturing growth (IIP-Manufacturing averaged just 3.8% in H1 FY26 against 5.7% in FY25). In short, lower output, fewer jobs, and weaker exports. The tilt towards medium enterprises further
aggravates the pain for smaller enterprises, where the most manufacturing jobs are created, turning a solvable liquidity issue into a systematic drag on inclusive industrial growth rooted in deferred technology upgrades and skilled labour shortages (25% of manufacturers cite skilled workforce gaps tied to underinvestment). Compounding this is the inadequacy of collateral-free mechanisms. The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE)—the cornerstone for unsecured lending—caps coverage at ₹10 crore per borrower (effective April 2025), enabling term and working capital loans without collateral for eligible MSEs. While cumulative guarantees have exceeded 1 crore approvals, covering ₹9.8 lakh crore in credit, actual availed amounts remain dwarfed by needs, averaging under ₹5 lakh crore annually, due to high guarantee fees (0.37-1.35% based on loan size) and paradoxical lender hesitancy for riskier micro units. In contrast, maximum credit availed under priority sector lending hovers at ₹1 crore composite limits for many, far below the ₹50 crore+ aspirations of scaling manufacturers, leaving 40% of formal MSMEs credit-constrained and trapped in a vicious cycle of
underutilisation. In essence, India’s MSME credit bottleneck is not merely an administrative hiccup but a throttle on the manufacturing engine of the economy, which powers almost half of exports and industrial jobs. As delinquencies creep up (1.8% overall, with early stress in NBFC term
loans) and global tariffs loom, this ₹30 lakh crore void risks amplifying a manufacturing slowdown into a full-blown sectoral recession, jeopardising GDP growth forecasts of 6.5-7% for FY2026. Urgent reforms from cash-flow-based lending to deeper CGTMSE infusions are
imperative to unleash this pent-up potential, ensuring MSMEs don’t just survive but propel.
Cash Flow Based Lending:
Cash flow-based lending is a credit assessment approach wherein lenders tend to evaluate a business’s ability to repay the loan based primarily on projected cash flow models and historical cash flows by analysing bank statements, tax returns, utility payments, etc., for over the last 6 or 12 months instead of traditional asset- or collateral-based assessment. The loan is sanctioned based on the ability to generate cash instead of the ability to pledge
assets. This approach becomes critical for MSMEs by making lending with zero collateral a loan based on digital transaction trade instead of compiled financial statements. Cash flow-based lending has lowered the bar for borrowing for MSMEs by not requiring past records or property collateral but the ability to repay the debt.
New to Credit (NTC) –
First-time borrower MSMEs have become the dominant share of new MSME organisations, with numbers as high as 56% in specific quarters, with FY 2024-25 seeing 13.2 Lakh NTC MSMEs. TransUnion reported 7% YoY growth in origination value for sub-₹1 crore loans in a recent edition. NBFCs and private players played a key role in this segment, reflecting NBFC-led CFBL. Multiple sources show the improving or stable growth in delinquencies (the
borrowers not paying back the debt), even with increasing NTCs, suggesting that CFBL has been helpful in finding the creditworthy NTCs. RBI and the advisory panel have advised using CFBL to promote credit access to MSMEs. The government, in its MSME guidance material, has explained CFBL and how to use it. Thus, formal policy along with has reduced any barriers that would restrict lenders from using CFBL while onboarding NTCs.
ULI as a Glimmer of Hope:
ULI (Unified Lending Interface) is a technology platform developed under the Reserve Bank Innovation Hub, which aggregates consented data from borrowers and provides a standardized API that lets lenders access verified data for near-instant credit appraisal. The formal pilot for the platform began in mid-August 2023 and is currently in its advanced pilot phase. As of April 2025, RBI reported that ULI facilitated over 1.4 million loans amounting to about ₹65,000 crore—though the pilot only included 36 lenders (commercial banks, small finance banks, regional/rural banks, and NBFCs). Reports have suggested a substantial share of loans availed to MSMEs, amounting to ₹14,500 crore reported in Dec 2024 – the latest reports are unavailable.
ULI reduces major frictions faced by smaller enterprises that cause exclusion:
● Faster underwriting and disbursal: verified data via APIs cuts appraisal time and paperwork massively.
● Better understanding for MSMEs new to credit: alternative financial data like GST returns, supplier/buyer data, and digital invoices lets lenders assess creditworthiness on multiple dimensions, such as cash flow, beyond just traditional collateral.
● Lower operating costs for lenders: a standard API coupled with shared services slashes the per-loan processing cost, making smaller loans for MSMEs commercially viable.
● Competition among lenders: multiple lenders can plug into the same data rails, increasing the supply and competitiveness of services tailored for MSMEs.
These features of ULI promise a much higher formal credit penetration for smaller enterprises, potentially pushing formal access from an abysmal ~15-20% to a much higher share. That could convert many lakh crores of previously unmet demand into formal credit over a span of just 3-5 years, not because ULI provides capital alone, but because it lowers costs and risk assessment barriers that prevent lenders from offering smaller loans.
(illustration by PwC).
In its pilot stage, it’s too optimistic to assume a success of the scale-up of ULI, as it does depend upon multiple factors such as its ability to keep pulling reliable data, adoption among lenders, consent clarity for borrowers, and last-mile digital access (X% of smaller enterprises lack the digital footprint that ULI relies on). Though, these can easily be mitigated by active policy levers from the institutions, such as accelerating data onboarding, using targeted
incentives like partial guarantees for smaller banks and NBFCs, and of course investing in assisted digital onboarding for the smallest of enterprises.
Schemes Launched by Governments:
The government had launched a financial scheme—Central Government Trust for Small and
Micro Enterprises (CGTSME)—where the government will serve as a guarantor for SMEs
who don’t have collateral assets to offer against the loans up to 2 crores. The main objective
is that the lender should give importance to project viability and secure the credit facility
purely on the primary security of the assets financed. The Government of India has
sanctioned an amount of over Rs11.5 Lakh Crore across the country, according to the
Ministry of MSME.
Another scheme launched by the government is the Mutual Credit Guarantee Scheme for
MSMEs (MCGS-MSMEs), wherein it would provide a credit guarantee coverage of 60% on
loans up to 100 crores INR for eligible MSMEs to help them purchase machinery and
equipment. According to the scheme, at least 75% of the cost of the project must be used for
the purchase of machinery or equipment. The scheme is applicable until January 2029 or
until a cumulative guarantee of Rs.7 Lakh Crore is achieved, whichever is earlier. To ensure
the borrower’s commitment, an upfront amount of 5% of the loan is required from the
borrower.
Lending under PMMY focuses on the unfunded segments of the microenterprises by
granting the loans in the following 4 categories to enable them to contribute significantly to
the nation’s GDP:
Peer Analysis with China, Vietnam and Indonesia
China:
In China, MSMEs are one of the main driving forces of the economy, contributing to over
60% of GDP and 90% of the total enterprises in the country; they also account for 80% of
the jobs. These MSMEs dominate manufacturing, construction, and industrial services.
They truly dominate the economy in terms of jobs, revenue, and innovation.
Apart from government subsidies, tax breaks, and industrial clusters, what truly sets Chinese
MSMEs apart is credit availability. China has significantly expanded loans towards smaller
enterprises, with total outstanding credit reaching over USD $4.5 trillion, about 30% of the
MSME GDP—while India lags at just over 10%.
The government and banks in China have raised loan caps for MSMEs and even lowered
interest rates, which has eased their cash flow constraints. While MSMEs in India still suffer
from inadequate loan amounts and high interest rates even from the formal sector.
Moreover, Chinese lenders have long adopted data analytics and advanced digital tools to
facilitate cash flow-based lending, overcoming collateral requirements, which still constrain
Indian MSMEs. China’s SME banking penetration stands at approximately 76%, driven
largely by state-backed digitisation efforts and fintech partnerships, highlighting widespread
adoption of digital lending solutions among MSMEs.
China’s credit guarantee funding for MSMEs (often called credit risk mitigations or CFBL,
Credit Financing Backed by Loans) started taking shape formally around the early 2010s. By
2015, rural commercial banks overtook city commercial banks in outstanding MSME loans,
reflecting expanded credit outreach to smaller firms. MSME loans in China grew at rates
exceeding 10% annually in the mid-2010s, with micro-enterprise loans growing the fastest.
The credit expansion allowed MSMEs to increase investment, innovate, and scale
production, contributing to their success in industrial and export sectors.
China launched its National Financing Credit Service Platform in 2024 to further integrate
credit information and service delivery across financial institutions for MSMEs. This platform
has facilitated trillions in loans and millions of credit enquiries, showing a strong evolution of
credit infrastructure. The 2024 platform initiative significantly increased loan volumes—over
RMB 25 trillion by early 2025 (PBoC).
Vietnam:
MSMEs constitute about 40% of the total GDP of Vietnam as of 2025, acting as one of the
key employers and conducting export-orientated manufacturing in the country. Thus, the
government believes in its importance and constantly aims at the growth of these MSMEs. In
January 2025, more than 33,400 enterprises were newly established or returned to
operation, an increase of 15% over the same period last year. Among these, nearly 10,700
establishments were newly registered with a total capital of about $3.764 billion dollars and a
total number of more than 81,500 employees.
Vietnam’s MSMEs faced major problems such as limited access to bank credit, heavy
collateral requirements, low technology adoption, and difficulty integrating into global value
chains. The various ways in which these issues were countered helped and contributed to
the positive growth of MSMEs. According to the Vietnam MPI, more than 48,000
enterprises have adopted digital platforms in 2024 as compared to 16,000 in 2021. The
State Bank of Vietnam implemented a policy where MSMEs can get access to subsidised
loans at a 1.2% interest rate for the short run and 4.4% in the medium term. SMEs received
corporate tax exemption for up to 3 years under the SME support law (Decree 80/2021).
This has massively improved the cash flow and thus faster expansion. As compared to it,
Indian MSMEs are borrowing at an interest rate of over 9%, which makes the borrowing
expensive and unattractive to MSMEs, thus reducing their growth.
When it comes to collateral to be offered, the Indian government, through its scheme of
CGTSME, has tried to provide 75%-85% of guarantee coverage to various loans undertaken
by MSMEs capped at Rs. 2 crore. According to AMRO (Asean Macroeconomics Research
Organisation), Credit Guarantee Funds in Vietnam usually require a collateral of 15% of the
guaranteed amount. Even though this amount is low, it has caused hindrance in the path of
MSME credit. Only 30-35% of Vietnamese MSMEs can secure loans because of the lack of
collateral to offer with them.
According to MSME Pulse 2025, delinquencies among Indian MSMEs as of 31st March
2025 are equal to 1.8%. However, it is to be noted that when the amount of loans lent is less
than Rs. 1 crore, the rate of delinquencies rises to 3.1%. As reported by AMRO, the rate of
delinquencies in Vietnamese MSMEs reaches as high as 5-7%, thus probably justifying their
requirements for collateral against the loans offered.
Indonesia:
Indonesia has roughly 66 million MSMEs, and they account for 99% of total businesses in
the country and employ 97% of the workforce; thus, MSMEs are often considered the
backbone of the Indonesian economy. They contribute to over 60% of the GDP and have
proven to be a solid foundation of its economy.
Despite the heavy dependence on MSMEs, these enterprises are facing the issue of lack of
capital due to insufficient credit supply in the economy. Only about 7% of total bank lending
goes to MSMEs. The government estimates 18 million MSMEs have no formal financing,
and another 46 million need additional capital. The government came up with the Kredit
Usaha Rakyat (KUR) programme to provide low-interest business loans (effectively 0–6%
after subsidies) to entrepreneurs. Loans up to IDR 100 million ($6000) are collateral-free by
regulation, simplifying access for small firms. By 2025, KUR had disbursed credit worth $14
billion among 4 million borrowers in the country.
The government is trying to get all villages and rural areas online to promote e-commerce
and enable digital financing for the small enterprises of those areas, thus trying to promote
the infrastructural development in the country. This is a key step on which India, as a country
struggling with similar problems, can focus too, i.e., to try and improve the infrastructure in
the country, especially in rural India. Various digital tools (online markets, fintech) can be
promoted to link small firms to customers and finance.
Conclusion:
The Make in India initiative envisions the nation as a global manufacturing powerhouse, not just for manufacturing excellence streamlining growth but also for economic sovereignty. Yet, the nation stands at a crossroads, undermined by persistent credit drought specifically for MSMEs. As detailed, they underpin 30% of the GDP, 45% of the exports, and over 110 million jobs. The bottleneck in credit, fuelled by lender hesitancy, information asymmetry and
collateral demands, stifles not just innovation and scalability but also systematic risks, informal soaring borrowing at sky-high interests, manufacturing slowdown, and reduced overall global competitiveness of Indian manufacturing.
Yet this is still no fated doom but a call for bold, transformative reforms. Two peer nations,China and Vietnam, serve as examples. China’s credit penetration at $4.5 trillion USD via digital analytics and state-backed guarantees has propelled exports, and subsidised loans and tax exemptions in Vietnam have spurred growth. We can emulate and, more importantly, innovate our own models. The start has been strong with collateral-free loans via CGTMSE and marginal CFBL, but it is time to scale these up.
The hope shines brightest in ULI, which, in its pilot alone, unlocked Rs 65,000 crore by slashing appraisal time, facilitating CFBL, and slashing the cost per borrower by leveraging strong digital infrastructure. Scaling ULI with digital literacy for owners of even the smallest enterprises could be transformative and help reach the target of ₹90-95 lakh crore.
Finally, resolving this enigma is not optional. Enterprises don’t call for subsidies but for strong credit. By prioritising an inclusive digital integration and strong risk mitigation, India can not only just survive but truly dominate global manufacturing, propelling her to a truly self-reliant, trillion-dollar horizon. The time for rhetoric and false promises is over; action must forge the future.
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