The government is contemplating the establishment of a dedicated bank to provide direct lending to micro, small, and medium enterprises (MSMEs). This initiative aims to enhance credit flow to the under-served sector, thereby boosting economic activity and job creation.
Current Scenario and Challenges
Presently, the Small Industries Development Bank of India (SIDBI) primarily provides refinancing to banks that lend to MSMEs, which helps reduce financing costs for these units. Additionally, state financial corporations and state industrial development corporations lend directly to MSMEs.
Despite these efforts, MSME credit penetration in India remains at 14%, significantly lower than 50% in the US and 37% in China, according to an EY report. The Indian MSME sector faces a credit gap of Rs 25 trillion, indicating a vast untapped market.
Proposal Details
“There is a need to set up a separate bank for the MSME sector to address direct credit shortages,” an official said, noting that the proposal is under consideration. The government is expected to decide on this proposal at an appropriate time. The bank’s ownership structure might include a hybrid public-private partnership model.
Financial Context
Adequate, timely, and low-cost finance is crucial for MSMEs’ growth into larger enterprises. As of December 2023, outstanding credit to MSMEs by scheduled commercial banks had grown by 20.9% annually, reaching Rs 26 trillion.
Significance of MSMEs
MSMEs, numbering 64 million, are vital to the Indian economy. They provide over 110 million jobs, accounting for 23% of the labor force, making them the second-largest employer after agriculture. MSMEs contribute 27% to India’s GDP, 38.4% to the total manufacturing output, and 45% to the country’s total exports.
Industry Insights
“A separate bank that understands the needs and workings of MSMEs is required,” said Sandip Kishore Jain, President of the Federation of Indian Micro and Small & Medium Enterprises. He emphasized that large banks often do not grasp the unique requirements of MSMEs. In some European countries, MSMEs are grouped with home loan customers due to their small borrower status.
Vijay G Kalantri, President of the All India Association of Industries, suggested converting SIDBI into a full-fledged bank for direct MSME lending if establishing a new bank is not feasible. He also advocated for MSMEs to receive loans at housing interest rates, i.e., 6% for exports and 8% for domestic production, compared to the current rates of 11-13% for MSMEs and 8-9% for exports.
SIDBI Overview
Established under an Act of Parliament in 1990, SIDBI’s majority shareholders include the Government of India (20.85%), State Bank of India (15.65%), Life Insurance Corporation of India (13.33%), and the National Bank for Agriculture and Rural Development (9.36%).
SIDBI benefits from low-cost funds available from banks against their shortfalls in meeting priority sector lending (PSL) targets. For FY24, the MSE Refinance allocation was Rs 84,000 crore. However, SIDBI’s growth prospects are tied to the PSL target coverage achieved by scheduled commercial banks. As these banks progressively meet higher PSL targets, the overall allocation under MSE funds could decrease, affecting SIDBI’s long-term growth prospects, according to an ICRA report.