What are the pros and cons of leveraging NBFCs by MSME Sector?

MSMEs make up the backbone of the Indian economy today, with the industry being one of the key growth drivers of the economy. The Indian MSMEs sector is estimated to contribute about 29 percent towards the GDP through its national and international trade.

The Indian government too recognises their crucial role in our economy and continues to introduce several policies to give a helping hand to the sector. This includes initiatives such as the ‘India Export Initiative’ and ‘IndiaXports 2021 Portal’ to boost MSME exports and increase their visibility.

The small and medium sized enterprises are the greatest indicators of a country’s economic health, and can provide crores of job opportunities.

As the economy continues to grow, so has the need for a strong finance infrastructure with less rigid frameworks. India has been a country traditionally run by banks, but the rise of NBFCs has encouraged many investors to explore the shadow banks, as they are called.

NBFCs play a crucial role for many sectors today, by granting loans for new ventures, and acting as a monetary pillar for many upcoming MSMEs. Generally categorised into three types, namely loan companies, asset companies, and investment companies, these institutions have evolved over the years to also provide a wide range of financial advice like small-reserves and advances.

One of the biggest advantages of leveraging an NBFC for MSMEs is the flexibility it offers. As new age finance institutions, NBFCs are systematically evolving to enhance their customer service and usually have a far more lenient eligibility criteria than banks.

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For many upcoming MSMEs, flexibility is the most important criterion, and NBFCs have, through the years, made a place for themselves in the economy through less stringent rules and regulations.

Since NBFCs are under the Companies Act, lending rules and regulations are not as rigid as banks. This is crucial for MSMEs, so they can receive loans with ease to arrange the timely funds they need to set up their business. Additionally, borrowers are also empowered due to less complex loan processing as compared to banks.

Additionally, when it comes to granting loans, a major criterion for eligibility is a candidate’s credit score, which is absolutely essential for banks and often comes in the way of many entrepreneurial dreams.

NBFCs today have a far more holistic credit evaluation process, and have their own evaluation system in place, to effectively analyse the credit worthiness of the borrower. They also follow a more accommodative and innovative approach to loan eligibility, and are not as rigid as banks.

Banks are also known for an excruciating amount of paperwork and loan processing requirements and documents. In comparison, NBFCs are relatively more agile and hassle free, and are able to garner the attention of loan seekers due to minimal documentation and paperwork.

Owing to fast processing, many borrowers are prepared for compromising on rates of interest, when the loan amount is not too high, so they can get approval fast.

Furthermore, most NBFCs today are new age technologically equipped institutions, providing real time customer service and virtual assistance to help clients stay up to date about loan details, payment, and extra charges for using their accounts online.

However, ultimately, security is an important consideration for every MSME. According to IBEF, the country reportedly has about 6.3 crore MSMEs, and as long standing financial entities in the country, banks offer a safer bet for upcoming businesses.

Furthermore, since banks have a very stringent loan processing mechanism, their interest rates are also low. Banks are built on trust, and can offer cheap loans with the added promise of safety, for MSMEs all across the country. Since they cater largely to the organized sector, with the promise of security, they usually make more sense economically in the long run, than many NBFCs.

They also provide an identity, which is recognised by several government institutions. NBFCs are not allowed to accept deposits which are repayable on demand whereas banks accept demand deposits. Banks are a very important part of the payment and settlement cycle while NBFCs are not a part of this system.

Furthermore, as government authorized financial intermediaries, banks can provide additional services such as providing overdraft facility, issue of traveller’s cheque, transfer of funds, etc., which is not possible for an MSME.

Recognising the regulatory gaps between NBFCs and Banks that needs to be bridged, the RBI has prescribed strict norms on capital adequacy and NPA. In a vibrant and growing economy like India, both players offer something unique to MSMEs, and play an active role in promoting their growth and development.

In the future, both institutions will co-exist to provide the best benefits to borrowers, in order to build MSMEs that will serve as a key employment generator for the country’s population in the coming years.