Government Considers New Bank to Address Credit Gap for MSMEs

The government is exploring the creation of a dedicated bank for direct lending to micro, small, and medium enterprises (MSMEs) to enhance credit access in this under-served sector, thereby stimulating economic activity and job creation.

Currently, the Small Industries Development Bank of India (SIDBI) primarily provides refinancing to banks that extend loans to MSMEs, helping reduce the cost of finance for these units. State financial corporations and state industrial development corporations also directly lend to MSMEs.

According to a report, MSME credit penetration in India is only 14%, compared to 50% in the US and 37% in China, indicating a significant credit gap of Rs 25 trillion in the Indian MSME sector.

"There is a need to establish a dedicated bank for the MSME sector to address direct credit shortages," said an official, noting that such a proposal is under consideration. The government will decide on the proposal at an appropriate time, with details such as the ownership structure, potentially involving a public-private partnership model, still to be finalized.

Adequate, timely, and low-cost finance is crucial for MSMEs to grow into larger enterprises. As of December 2023, the outstanding credit to MSMEs by scheduled commercial banks had increased by 20.9% annually to Rs 26 trillion.

With 64 million MSMEs, this sector forms the backbone of the Indian economy, providing over 110 million jobs (23% of the labor force) and contributing 27% to India's GDP, 38.4% to the total manufacturing output, and 45% to the country's total exports.

"A dedicated bank that understands the needs and operations of MSMEs is required," an expert emphasized, noting that large banks often do not comprehend MSME requirements. In some European countries, MSMEs are categorized with home loan customers as small borrowers.

Another expert suggested that if a new bank is not feasible, SIDBI should be transformed into a full-fledged bank for direct lending to MSMEs, instead of focusing solely on refinancing.

The expert also proposed that MSMEs should receive loans at the same interest rates as housing loans—6% for exports and 8% for regular domestic production activities. Currently, MSME loan interest rates are 11-13%, and 8-9% for exports. He also highlighted that MSME credit as a share of their output has decreased from 12% to around 8.3%.

SIDBI, established under an Act of Parliament in 1990, has major shareholders including the Government of India (20.85%), State Bank of India (15.65%), Life Insurance Corporation of India (13.33%), and National Bank for Agriculture and Rural Development (9.36%).

SIDBI benefits from low-cost funds provided by banks to meet their priority sector lending (PSL) targets. For FY24, the micro and small enterprise (MSE) refinance allocation is Rs 84,000 crore. SIDBI's growth prospects are tied to the extent of PSL target achievement by scheduled commercial banks. As these banks meet higher PSL targets, the overall MSE fund allocation might decrease, potentially affecting SIDBI's long-term growth, according to an Icra report.