The first blog in this series highlighted the context of the Mor Committee’s recommendations and the significant gap between the supply of and demand for credit for small businesses. The second blog in the series examined the role of the banks, development finance institutions and non bank financial institutions (NBFCs) to examine why they have been so backward in coming forward to meet this gap. This concluding blog looks at the ways of measuring access to finance for small businesses.

Credit to GDP Ratio – Is it a Good Measure to Assess Access to Finance for Small Businesses?

The Mor Committee report recommends that by January 2016 every significant (more than 1 per cent contribution to GDP) sector and sub-sector of the economy should have a credit to GDP ratio of at least 10 per cent. The Committee recommends use of credit to GDP ratio to assess the extent of credit reach to various sectors in the economy. The report highlights that India at its abysmal 70 per cent credit to GDP ratio is way below the averages of high-income countries (200 per cent) and the middle-income countries (100 per cent). The Committee argues that targeting 10 per cent credit to GDP ratio for all significant sectors by 2016 would catalyse inclusive growth and subsequently reduce poverty.

At the small businesses level, the report presents the finding that the credit to GDP is 35 per cent at an aggregate level. Similarly at industry and services level, the ratio stands at 56 per cent and 25 per cent respectively.

In our analysis of subsectors within the MSME segment at the two-digit level of NIC-2004 classification, MicroSave found that of 47 sub-sectors only five, namely Food Products and Beverages; Textiles; Chemicals and Chemical Products; Basic Metals; and Fabricated Metal Products contribute greater than 1 per cent to the GDP. In terms of access to finance, these five subsectors had comfortable access ranging from 49 to 101 per cent. Thus, we observe that while credit to GDP may be a good ratio to determine access to credit at the aggregate and sectoral level, at the sub-sector level it does not hold relevance.

Also, the targets assigned for January 2016, at 10 per cent credit to GDP is not relevant for the MSME sector per se as all the sub-sectors within MSME segment have greater than 10 per cent credit to GDP ratio. The credit flow is skewed in favour of medium enterprises with micro enterprises languishing for want to institutional credit.

A World Bank study highlights that access to credit is inversely related to firm size. Size is a significant predictor of the probability of being credit constrained and hence micro and small enterprises are highly credit constrained. In such as scenario, credit to GDP ratio would not sufficiently reflect the access to credit to small businesses. Lack of a clearly articulated and representative ratio may mean that the banks and financial institutions would expand access to credit to the MSME sector as a whole by focusing largely on medium sized enterprises.

Thus, it would be worthwhile to use the formal credit to capital ratio to measure the access to credit by small enterprises. The underlying assumption upon which this indicator is suggested is the fact that it clearly defines the leverage of the enterprises. Also, in our opinion, instead of looking at MSME sector as a whole, it is important, for the purposes of measurement of access to credit to look at the micro, small and medium enterprises individually.

Another measure in line with the suggestions of World Bank’s report on assessment of credit constraints for enterprises is the credit-constrained status of the micro, small and medium enterprises. World Bank suggest that the enterprises can be classified as below:


The status of all enterprises across the size ranges can be assessed periodically to estimate the access to finance. This will provide a better understanding of the access to credit amongst micro and small enterprises, and thus focus policy makers’ attention on these key drivers of Indian economic growth.

  1. MSME is the sector which need government interventions. Not only in gives employment to large no of people also contribute around 44% of total manufactured goods. They need support at raw material procurement also at the market linkage level. Government can think of raw material banks from which a MSME player can take raw materials and also there has to be an assured source where goods can be sold. Banks can lend the raw material bank through an escrow.

    This is just an idea there can be lot more ways to do it. Cluster development is approach is also a good idea. All cluster are unique and can be studied properly and business case can be generated. Key is banks has to open up them self and take an innovative way of lending.

    • Banks in India have entered into cluster based financing. However, the model is still marred with challenges such as bank’s ownership and willingness to be part of the model rather than being an outside lender to the MSMEs. Also, banks still treat MSMEs from a cluster no different from any other MSME and thus shy away from providing better interest rates or higher amount loans. Having said that the viability of cluster based financing can not be denied. If it worked for China there is no question why it can’t work for India too.

  2. Credit flow is highly skewed among the MSME units because economic growth basically in terms of infrastructure is highly skewed among the region.: Eventually, the two other factors namely productive absorbing capacity of the credit in the given area and capability of the prospective clients to start such units assume significance . These demand side factors are more useful prudent indicators for credit planning than macro level one linking with GDP from supply side perspectives .
    Dr Rengarajan .

    • Thanks a lot for your reply. It does add a very significant dimension of demand side assessment as being more prudent for credit planning. State GDP may vary drastically considering the fact that many states in India are still way below the national average. Thus the geographical distribution of financing needs to be incorporated as an indicator to ensure an equitable distribution of finance is monitored.

      The relation between infrastructures leading to greater flow of finance is a natural phenomenon. Thus financial institutions are always sceptical to enter in a market/geography with poor infrastructure. However, this scepticism to invest in poor infrastructure geographies further reduces the probability of any cluster or MSME developing in such geographies, precisely due to lack of institutional finance. Thus, it is imperative that red flags are raised in sector studies and reports on such instances and cases. An indicator on demand side with the aforementioned perspective is critical to assess growth of institution finance to MSME across country. While the Mor Committee has raised this, we are of the opinion that the two indicators you mentioned may add more granularity in assessment of reach of the institutional credit.

      • Thanks for your endorsement on my views. Two points merit mention again on the subject
        a) Appreciation of casuistry for exclusion and the factors sustaining the inclusion in the finance domain inevitably calls for more granulated perception on the given profile and geography in the demand side and prudent infrastructure planning followed by sequencing the appropriate financial products in the supply side instead of surface level misconception even after many decades of financial intervention..
        b) Such infra planning and implementation need to be done by government in a manner to create interconnected ecosystem for responsible inclusion and productive functioning institutional credit at micro level . Credit ( be it mobile or bank) alone cannot work by default in the given ecology. In the absence of above fact in the backward area like eastern region in particualr , exclusion is prominent as also evidenced by prolonged presence of low CD ratio of the banks ( For more insights on this vital fact, refer Dr.C. Rangarajan’s committee report on financial inclusion page 106 (2008). In the absence of demand side analysis ,focus on mere digitalized delivery of financial services (Mor) would not serve ultimate purpose of inclusion be it small business or any economic activities financed.
        Dr Rengarajan

  3. I feel that the Bankers on the field need some motivation too. If we look at the performance indicators upon which a branch and its staff are evaluated the apparent focus on advances and deposits in terms of their gross numbers and relative growth vis-a-vis targets are taken into account. Now, let’s take a case of two branches A and B respectively, both are similar in terms of targets and both achieved them too. Details are below:

    Branch A- 50 million rupees advances , 50 customers in portfolio

    Branch B – 50 million rupees advances, 5000 customers in portfolio

    The case is hypothetical but I just want to point out that Small businesses need smaller loans and that means a lot of extra work compared to the Medium scale businesses. There is no apparent recognition or reward for a banker to scope and lend to the small businesses , which are percieved as riskier , so they resort to targeting the relatively bigger customers leaving the small ones at bay. Finding a way to incentivize the banker on this can also help.

    • Rightly pointed out Abhinay, it is always an added pressure for the bankers both in terms of time and effort to service and manage relatively smaller loans. The time is right for three key financial players banks, NBFCs and MFIs in India to refine their tactical approach. For banks, it makes sense to move downwards and customise products and services for small and medium enterprises. It may mean developing low-cost branches and assigning KPIs in terms of volume and value both to the branch staff members.

      For MFIs, the opportunity exists to scale-up with better products to service micro and small enterprises. On the other hand, NBFCs with their large presence in the vehicle and personal financing solutions and proven experience of working with high risk clients can diversify into small enterprise financing.In both the cases, a focus on numbers of entrepreneurs served should be primary driver of business incentives and bonuses for the staff to focus on the under-served market segment.

      The need of hour is to be cost effective through effective credit assessment customised for target segment, innovative channels and modified/new products. Incentives to sales teams to procure and service clients can play a very major role to bring in the desired numbers.


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