How India’s Non-Bank Financial Companies are Closing the MSME Credit Gap — And What Other Emerging Markets Can Learn from Their Success
Micro, small and medium-sized enterprises (MSMEs) are usually considered the pillars of emerging economies, and not without reason. Globally, MSMEs make up around 90% of businesses and employ over half of the workforce. In emerging markets, formal MSMEs contribute up to 40% of GDP and create 70% of formal jobs — percentages that would be far higher if informal MSMEs and jobs were included.
Yet despite their key role in driving economic growth, these businesses face an ongoing credit gap, and in countries like India, it is a significant concern. According to a recent report from NITI Aayog, the Indian government’s premier public policy think tank, and the Institute for Competitiveness, only 19% of India’s MSME credit demand was met formally as of FY 2021, leaving an estimated ₹80 trillion unmet. This lack of funding limits Indian MSMEs’ ability to sustain and grow their businesses, reducing employment and economic growth across the country.
How alternative financing can fill India’s MSME credit gap
In India, MSME lending was traditionally handled by formal banking institutions. Borrowers had to provide collateral assets to secure business loans, and were required to have a formal credit history. However, over the past five years, many alternative financing approaches have emerged in response to the market’s need for quick and convenient credit. For instance, non-bank financial companies (NBFCs) have provided an effective solution to the MSME credit gap by offering more dynamic and flexible lending services than their bank counterparts. In contrast to the more rigid underwriting norms of traditional banks, NBFCs provide loans to borrowers who might have little formal documentation or a negligible credit history, and they respond rapidly to borrowers’ needs.
In the 2022-23 and 2023-24 periods, Indian NBFCs grew their MSME loan portfolios by 21.2% and 42.4% respectively, while traditional banks grew theirs by just 12.7% and 12.4%, according to the Reserve Bank of India’s report on banking sector performance. They also significantly increased their working capital loans, which generally consist of short-cycle credit that MSMEs use to finance their day-to-day operational requirements: The proportion of these loans to total secured debt in the sector increased from 66% in Q1 2023 to 71% in Q4 2023. This demonstrates that MSMEs now have greater access to credit.
One impact of this financing can be seen in the export value of the MSME sector, which has risen significantly over the last four years, growing from ₹3.95 trillion in 2020–21 to ₹12.39 trillion as of 2024–25.
The role of NBFC lending in powering MSME growth
The lending practices of NBFCs play a unique role in the development of India’s MSME sector. In the semi-urban and rural regions where sufficient data exists, it’s evident that loans extended to MSMEs are helping these enterprises to expand their operations, generate employment and support local economies. To take one example, a recent social impact report published by Niti Aayog, in collaboration with TransUnion Cibil and MicroSave, mentioned that “As of December 2024, 27 million women were monitoring their credit, marking a 42% increase from the previous year” — a signal of growing financial awareness among women entrepreneurs.
These numbers highlight a powerful multiplier effect, showing how credit, when focused thoughtfully, can fuel both economic and social transformation. Notably, many of these effects are found in underserved geographies, such as towns with a population of between 20,000 to 50,000 (also called tier 3 towns), and rural areas, where the higher cost of service has discouraged lenders.
The impact of this funding is growing, as climate-aligned MSME lending is emerging as a new focus area for NBFCs. These lenders are increasingly channelling money into green activities across India, ranging from solar power systems and irrigation, to sustainable packaging, cold storage and energy-efficient devices. Such focused lending allows micro-entrepreneurs to support climate objectives while driving profitable growth, thereby connecting local businesses with global sustainability efforts. Not only is this good for climate resilience, but it also helps NBFCs expand their loan portfolios: In our Social Impact Report for 2024–25, UGRO Capital found that a growing share of NBFC borrowers are prioritising green projects, particularly in supply chains that support India’s net-zero goals.
What other developing economies can learn from India’s experience
India’s experience offers useful lessons for other low- and middle-income countries that have similar credit challenges.
For instance, building digital public infrastructure has been essential to India’s ability to extend credit to underserved businesses. Programs like Aadhaar (a biometric identity platform), Udyam (a MSME registration platform), and the Goods and Service Tax (GST) system have made onboarding and underwriting more efficient. These interconnected digital systems have formalised the business data of smaller MSMEs and given prospective lenders a reliable source of business information. Now lenders can log into these interfaces and verify if the entrepreneur, for instance, has provided accurate info about their orders book. These efficiency gains have allowed NBFCs to lend lesser amounts at lower interest rates than typical lenders, enabling them to reach small businesses that otherwise wouldn’t be profitable enough to serve. Duplicating this sort of digital infrastructure, even partially, would make MSME lending more inclusive in areas like Southeast Asia, sub-Saharan Africa and Latin America.
Additionally, NBFCs’ use of alternative data-driven underwriting platforms is changing their approach to assessing MSMEs’ creditworthiness. For enterprises that don’t have collateral or formal credit records, NBFCs now use utility bills, GST returns, mobile payments and geotagged business activity to help determine a borrower’s ability to repay loans. These new tools are bringing previously “invisible” entrepreneurs into the realm of formal finance.
Finally, credit guarantee schemes such as the Credit Guarantee Fund Trust for Micro and Small Enterprises have demonstrated their effectiveness in de-risking the MSME segment. By taking on some of the lender’s risk, these structures make it possible for NBFCs to provide credit to higher-risk profiles without increasing interest rates. These types of mechanisms are scalable and could be expanded through multilateral collaborations.
A global call for coordination
As climate change gathers force, MSMEs are not only exposed — they are also key players in local adaptation and sustainability initiatives. Small enterprises in agriculture, logistics, energy and manufacturing are developing and rethinking models to adapt to climate shocks and resource limitations. But for those approaches to have maximal impact, the successful MSME lending models developed by India’s NBFCs must be scaled globally.
To that end, what MSMEs in India and around the world need is closer alignment between NBFCs, development finance institutions (DFIs), policymakers and impact investors. The MSME lending sector has already shown it can lend responsibly, use new technologies and reach underserved businesses. But for this momentum to be meaningful and scalable, a stronger support system needs to be in place, and greater transparency is necessary.
It is not enough if NBFCs’ interactions with investors and DFIs are restricted to only providing information about disbursement volumes or repayment percentages. These stakeholders also need to know the tangible results of providing credit to these businesses, such as the number of jobs created, the number of women-owned enterprises that grew in size, and the amount of lending that supported green innovation.
NBFCs have already demonstrated that inclusive lending is both possible and effective, and that small companies with the right risk perspective can be major drivers of development. What is needed now is capital — from governments, DFIs, philanthropic funds and private investors — to invest in long-term results rather than short-term returns. Effective measurement systems are also needed to unlock the full value of lending, highlighting its impact on economic growth, social mobility, gender inclusion and climate resilience.
It is time to acknowledge NBFCs not only as financiers, but as development partners — and to assist them in unleashing the full potential of MSMEs as drivers of growth, resilience and inclusion.
Sameer Nanda is Chief Revenue Officer at Ugro Capital Limited.
Photo credit: Atstock Productions
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