Reducing the Debt Gap for SMEs

by Vinaya HS on February 2, 2015

in Finance

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In a developing country like India, the micro, small and medium enterprises (MSMEs) play a very important role in contributing to the economic development. Being the second most populated country in the world, we have a huge population to serve and these MSMEs that are built on innovation and talent, help in reaching out to the spread out billions.

The Small and Medium enterprises in India (SMEs) contribute 45% of the total industrial output, hence becoming a crucial part of our economy. They also contribute to 40% of the country’s total exports, employ about 60 million people and create 1.3 million jobs every year.

While there are a lot of perks and benefits for the SME sector in India, they still continue to face a lot of difficulties and challenges. An important one in the list is getting the right and secure source of SME financing. This lack of available funding for SMEs has only been highlighted post the credit crunch in our country.

Funding gap in SMEs

According to a report by the International Finance Corporation (IFC), the total financing demand gap in the SME sector is of Rs 2.93 trillion. Research shows that most formal lenders prefer traditional-collateral based lending and look for at least three years of profitable track records. Such expectations out of newly opened innovative companies makes loans for SMEs out of reach.

Reasons for the increase in the debt gap

A lot of these SMEs are run by entrepreneurs who have little or no experience in raising SME finance. Others are family-owned and have less information about tapping the right kind of financing. There is also information asymmetry, which exists in these SMEs, causing the debt gap to increase.

Also, traditionally SMEs prefer taking private funds from family and friends, which is the largest source of finance for this sector in India. Some also rely on private moneylenders and some players from the unorganized financial sector for their SME finance needs. The terms of these deals are typically unclear and interest rates are very high.

While banks are making efforts to bridge this gap, the rules and regulations in the banking industry makes it very difficult to do so. In any application for loans for SMEs, the bank has to evaluate the risks involved and see the collateral support. It becomes difficult for entrepreneurs with small businesses to satisfy all the conditions and requirements that the bank will ask for.

Thinking from the bank’s point of view, they have to be restrictive to create value by controlling and managing the risks and are right in their scrutiny.

Government support for SME funding

The Indian government has always been aware of the funding gap that exists in the SME finance sector and they keep announcing some sort of relief mechanisms to support them. Their initiatives have helped in coming till here and ensuring that we continue to get our set of good entrepreneurs but more needs to be done to take it to the next level.

This article has been contributed by SMEcorner – India’s first online loan application platform.

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