NBFCs to continue to dominate MSME credit market: Report

Non-banking financiers will continue to dominate the lending space to MSMEs which have been out of the formal credit system for long, and their share of loans to this segment is expected to reach over 20 per cent in the next two years, says a report.
As of fiscal 2017, the MSME credit market stood at Rs 14 trillion which may grow by 11 per cent each in the next two years, rating agency Crisil said today.
"Over the past five fiscals ending 2017, non-banking finance companies recorded a four-fold increase in their credit book to MSMEs. Consequently, their cumulative market share in MSME financing rose to 18 per cent in fiscal 2017 from 8 per cent five years ago," Crisil said, adding this will rise to over 20 per cent in two years.

Lenders have been trying to protect their return on assets by focusing on smaller loans, where yields are higher, and on unsecured loans. For NBFCs, unsecured loans account for 20 per cent of the MSME portfolio as of March 2017.
And the agency sees the trend continuing for at least the next two years. "Over the next two fiscals, too, we expect NBFCs to outperform banks with sharper focus on small-ticket loans, adoption of technology and data analytics, and focus on smaller towns and cities."
Overall the formal credit to the MSME sector is seen clipping at 11 per cent each over the next two years, it said, adding, however, this is lower than the 13 per cent. This is against industrial credit growth of around 7 per cent.

This faster growth is a result of the formalisation of the MSME finance market after the note-ban and the rollout of the goods and services tax.

"While MSME credit demand may rise 11 per cent each over the next two years, continuous tracking of sectors critical to managing risks is needed as the opportunities grow," Crisil said.
The report, however, noted that while competition has intensified and asset quality has weakened, the overall opportunity remains compelling, given the huge under-penetration of formal finance in the MSME segment. Moreover, structural changes such as GST will increase transparency in MSME financials.
Competition in MSME lending has intensified, putting pressure on yields. For example, in loan against property, the net interest margin has compressed 75 bps in the past two years, says Crisil senior director Prasad Koparkar.

Asset quality of MSME loans worsened due to demand side pressure and liquidity issues after note ban. Over the course of fiscal 2017, gross non-performing assets across lenders rose by 70-100 bps. With GST compounding the challenges for MSMEs, especially the unorganised lot, the overall asset quality picture will likely deteriorate before improving.
Competitiveness of MSMEs will be determined by the extent of tax avoidance, their position in the value chain, labour cost arbitrage, product offering, local market knowledge and proximity to customer, he said.
"The business potential for MSME units from the same industry, but in different clusters, can vary significantly," said Crisil director Ajay Srinivasan.