Chart of the Day: It is not banks but shadow banks that power India’s MSMEs

For long, public sector banks have been the enablers of entrepreneurship by helping India’s small businessmen get critical capital for their enterprises. But this is no longer true, as non-bank finance companies have emerged as the go-to counter for small businesses, especially sole proprietors.

Cast your eyes on the chart below, from a special report from SIDBI and credit bureau Crif Highmark, that captures the financial tapestry of India’s micro, small and enterprises.

NBFCs are increasingly the main lender for small businesses

It shows that in the June quarter of the current fiscal year, NBFCs provided 42.4 percent of the credit to sole proprietors and 33.8 percent of credit to sole proprietors with entity presence. Sole proprietors are self-employed people who have availed business-like loans, sole proprietors with entity presence are those that have availed loans in both the personal capacity and business loans for the purpose of the firm. Enterprises are straight up business loans availed on the behalf of a business. The share of NBFCs in all these loans has been rising steadily.

It stands to reason that NBFCs must cater to small businesses more than banks. India’s banks have traditionally preferred to extend loans based on documentation and a history of credit for any borrower. Banks also have less flexibility compared with their non-bank peers in underwriting credit and have tighter loan covenants. Small businesses with sole proprietorship tend to have flimsy documentation or an absent loan history. NBFCs are nimbler and more willing to underwrite such loans with a higher perceived credit risk.

This explains why NBFCs see more incidences of rising defaults in their MSME portfolio and typically have a higher delinquency rate compared with banks. The fact that shadow banks finance the riskiest business credit is reason enough to tolerate a higher bad loan ratio than other lenders.

The Crif-SIDBI report highlights that more than 75 percent of active loans to MSMEs are of less than Rs 10 lakhs and loan against property (LAP) is the most popular structure of borrowing that small businesses use, followed by working capital loans.