Top Five Reasons Why MSME Loans Fail

The MSME sector is one of the major contributors to GDP and the employer of a significant proportion of the population in India. The International Finance Corporation reports that there are approximately 56.1 million MSMEs in India which collectively contribute to more than 30% of the GDP, employ nearly 125 million people, and produce 45% of India’s exports. However, even though the MSME sector is considered to be the backbone of the economy, it suffers from issues with access to finance. IFC has estimated the credit gap for MSMEs in India to be at $397 billion.

MSMEs require finance to start the business, for daily working capital needs and expansion. Without adequate and timely access to finance, MSMEs cannot experience healthy growth and many ultimately shut down. Although there are many alternatives to raise finance, the most convenient and accessible source of finance for MSMEs is a loan. However, the process of obtaining a loan may be cumbersome, and many MSMEs fail to get loan approval. It is therefore essential for MSMEs to know about MSME loan eligibility and documentation requirements before applying for a loan so that the chances of rejection are minimised. 

Read on to know the top five reasons behind the failure of MSME loans:

1. Lack of financial awareness: Many MSMEs with tremendous potential for success get stunted because of the lack of financial literacy of the owner. There are numerous credit options and hosts of schemes, offered by the government for MSMEs, directed at easing their credit-raising difficulties. Some MSME owners are unaware or unwilling to access such schemes due to many types of inhibitions. They do not approach formal financial institutions for credit as they have no understanding of the offers being given by such institutions. Such MSMEs end up going to informal sources of finance, where they may have to pay higher interest rates and take more risks.

In the absence of adequate financial expertise, MSMEs often end up making wrong decisions regarding financing options. In such situations, it is best to seek professional advice from experts and get working knowledge on how credit works. There are portals that give comprehensive information about MSME loan providers, interest rates, EMI calculators, repayment tenure, etc.

2. Collateral Security: Financial lenders offer both secured and unsecured loans. In the case of high-risk borrowers, lenders may not offer unsecured loans. Since MSMEs are mostly perceived as high-risk borrowers, banks will demand collateral security against secured loans. Collateral securities that can be pledged by MSMEs are land, building, gold, securities, etc. But it is impossible for all MSMEs to always have such assets to be pledged as security. Under such circumstances, very often loans are rejected due to the inability of MSMEs to pledge collateral security.

Several collateral-free loan schemes are offered by the government under the umbrella of the Ministry of MSMEs. Also, many banks and NBFCs offer collateral-free loans to the sector. MSMEs can avail such schemes in the absence of collaterals.

3. Difficulty in documentation: Documents requirements for MSME loans may be cumbersome for many MSMEs. A significant majority of the MSMEs in India are, by definition, the micro and marginalised section of the business community. Many of these units cannot afford to maintain proper books of accounts, documentation or obtain all types of licences and clearances. Lending institutions have their own rules and regulations regarding MSME loan eligibility, and some of these institutions have quite strict requirements. A long and cumbersome documentation process and a longer sanction time demotivate MSMEs and force them to look for easier alternatives in the informal sector.

MSMEs can seek assistance from experts who can help them with the preparation of documents, licences, and clearances. Many schemes for MSMEs offer loans with minimal documentation.

 4. Indifference of lenders: It’s no secret that MSME borrowers are not the most lucrative category of borrowers for lending institutions. There are always bigger players in the market who are perceived as less risky by lending institutes. Many researches have proved that lenders, especially banks do not proactively attempt to woo MSME borrowers. In India, MSMEs are included in the Priority Sector Lending Mandate of the Reserve Bank of India for commercial banks. This means that commercial banks are required to direct a certain proportion of their aggregate credit towards a specific sector of borrowers, which includes MSMEs.

At the same time, businesses with good potential for success are preferable investments for banks. There are loan schemes that are especially directed towards MSME borrowers.

5. Lack of proper Business Plan: A good business plan is a basic criterion for the selection of an MSME loan application by lending institutions. At times, MSMEs lack a good quality business plan or are unable to present it properly to the lenders. This may lead to rejection of the MSME loan, even if the MSME has great growth potential. Therefore, a clear business plan should be prepared and presented in a convincing manner.

There are consultants available online who specialise in business plan preparation and offer this service for a minimal fee. Moreover, MSME owners can also undergo training for the preparation of quality business plans which are imparted by various organisations from time to time.

These are some of the top challenges faced by MSMEs in obtaining loans. However, these issues can be resolved by thoroughly going through MSME loan eligibility criteria and with a little homework before applying for that loan. MSMEs should carefully list out various alternatives available and conduct a thorough evaluation of lending institutions before applying for a loan. To save time, MSMEs must prepare required documents and obtain clearances/approval where required, in advance. Maintenance of proper records of transactions, timely tax payments and healthy cash inflow go a long way in ensuring hassle-free credit approval for MSMEs.


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