New RBI Norms May Increase Cost of NBFC Loans to MSMEs

Loans extended by non-banking financial companies (NBFCs) to MSMEs may become more expensive due to revised digital lending norms introduced by the Reserve Bank of India (RBI) earlier this month. The changes are expected to impact loans disbursed under credit guarantee schemes, which form a significant portion of MSME financing.

The new RBI norms prohibit regulated entities (REs) from entering into Default Loss Guarantee (DLG) arrangements on loans covered by credit guarantee schemes. Currently, such loans are eligible for zero risk weight due to existing guarantees. DLGs are contractual arrangements between an RE and another entity that compensates the RE for loan losses due to borrower defaults, up to a specified percentage of the loan portfolio. Under previous practices, Loan Service Providers (LSPs) would offer DLGs to NBFCs for loans falling under credit guarantee schemes. This mechanism allowed NBFCs to offset a portion of potential losses on defaults. However, with the latest restrictions, NBFCs will now be required to bear the full extent of losses on such loans, as LSPs can no longer provide DLGs for guaranteed loans.

Officials indicate that DLGs were typically capped at 5%. In the absence of DLGs, NBFCs will need to provision for potential losses, thereby increasing their cost of lending. One NBFC official noted that a loan previously backed by a 12% guarantee would now require provisioning at 15%, affecting interest rates.

The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) facilitates credit guarantees to banks and NBFCs, helping reduce credit risk and enabling lending to high-risk MSMEs. Loans under this scheme are known to carry competitive interest rates, thereby supporting access to finance for underserved segments. Despite a government push to improve MSME credit access, NBFCs express concern that the revised norms may raise the cost of lending. According to industry sources, the inability to obtain DLGs necessitates additional provisioning, which could be passed on to borrowers through higher interest rates.

As of March 31, 2024, MSMEs accounted for 8.9% of the total credit provided by NBFCs, up from 7.9% in 2023 and 6.5% in 2022. The overall share of NBFCs and banks in MSME credit rose to 11.7% in FY24, with a larger portion directed toward service sector enterprises.

While the norms aim to strengthen regulatory compliance and reduce systemic risks, stakeholders indicate potential short-term implications for MSME credit flow and NBFC profitability.