New Delhi: The central government may allow digital banks for small businesses to meet credit gap faced by about 60 million micro, small and medium enterprises (MSMEs) which compels these units to borrow from the informal sector, three people aware of the development said, adding that the upcoming Budget may provide a road map.
About 63.8 million MSMEs are the backbone of the Indian economy, creating over 111 million jobs. The share of their gross value added in the national GDP in 2020-21 was 26.83%. They represented 36% of India’s manufacturing output that year, with over 45% contribution in exports. They urgently need easy access to formal credit of around ₹25.8 lakh crore, they said, asking not to be named.
Despite the Reserve Bank of India’s move of financial deepening through various measures, including priority sector lending guidelines, MSMEs are not getting wide access to credit at scheduled commercial banks. They are forced to access capital from informal money markets such as moneylenders, chit funds or illegal loan apps, they said.
“They require more and easier formal avenues apart from the 75 digital banking units,” one of the people quoted above said. The digital banking units are arms of the State Bank of India, Punjab National Bank, ICICI Bank and HDFC Bank launched by Prime Minister Narendra Modi in 75 districts on October 16, 2022.
“Small ticket size of such loans, often between ₹1 lakh and ₹10 lakh, naturally does not make best commercial sense for traditional banks due to cost-benefit concerns. Commercial banks consider it a compulsion rather than incentive. If India has to become a $5-trillion economy, it can no longer ignore credit needs of MSMEs,” a person working for the Union government said.
A second official said while digital banks function like traditional lenders, they do not have brick and mortar branches. They also take deposits and lend money in a regulated environment, but without any physical paperwork. They extensively use data of clients to process loan applications and lend accordingly.
“Allowing such banks may have some regulatory challenges, which must first be addressed by RBI before licences could be granted to both private and public sector entities,” an official working in an economic ministry said. “It is a work in progress.”
Email queries sent to the ministries of finance, micro, small and medium enterprises and RBI elicited no response.
Another person, an expert advising the government on such matters, said: “It is prudent to be cautious. Full-scale digital banks similar to existing commercial banks would not resolve credit problems of SMEs. Hence, allowing digital banks exclusively for SMEs is the right solution, which can also take deposits from businesses only. Regulatory challenges could be minimised if they are not allowed to take retail deposits. Besides, they will have to follow RBI’s banking guidelines, which can be suitably modified for SME digital banks.”
Banking and MSME sector experts said rapid digitisation of banking services in India is globally appreciated and it has now achieved critical mass in terms of Jan Dhan accounts, UPI, BHIM, online assessment and payment of taxes. Now, the need is to move to the next stage beyond payment system.
“Digital is creating many opportunities and is also making solid inroads into the financial inclusion paradigm. Digital banking, especially payments, once a novelty, is now a necessity,” said Jatinder Mohan Singh Shah, chief operating officer, business banking at Fincare SFB, a small finance bank.
The digital revolution in terms of financial inclusion is exemplary even for most advanced economies, said Vinod Kumar, president of the India SME Forum. “Now there is a need to take benefit of technology to meet credit needs of MSMEs,” he said.
MSMEs are heterogeneous and their credit demand are unique, hence digital banks with their flexible and innovative ways can serve them better than traditional commercial banks, he said. “For every micro and small business, capital is the driving factor and digital lending would make it much easier for neglected and marginalised entrepreneurs, spread across the length and breadth of the country to get much-needed access to finance from a regulated channel,” he said.
Many MSMEs are forced to pay up to 48% annual interest rate for money borrowed from the informal sector, Kumar said. While interest rates charged by regulated channels other than commercial banks are lower, they are compounded annually, hence often cost up to 36%. “Imagine how MSMEs would do business with thin margins of 15-20% after taking such costly loans. Due to lengthy paperwork, they often lend up in the vicious debt trap of informal sector,” he added.