Credit Uptick Masks Deeper Gaps in MSME Lending Until lending models evolve to meet the real-world needs of these businesses, especially those outside metro hubs, India's small business engine will continue to run below capacity

India's micro, small and medium enterprises (MSMEs) are seeing an unprecedented surge in formal credit, yet the gap between potential and reality remains stark. The total outstanding portfolio in the MSME credit sector soared to INR 40.4 lakh crore by the end of March 2025, a 20.1 per cent jump from INR 33.6 lakh crore in March 2024 and a significant leap from INR 28.3 lakh crore in March 2023. But experts warn; the surge, while promising, isn't enough.

Micro and small enterprises continue to anchor this sector. According to a report by CRIF High Mark, businesses with small-exposure accounted for 40 per cent of total outstanding credit as of March 2025, while micro-exposure businesses, those seeking smaller loan sizes, made up a dominant 81.1 per cent of loan volumes. Credit exposure for micro businesses grew 19.7 per cent year-on-year, and a staggering 45.3 per cent since March 2023. These gains are closely tied to the Udyam Assist Platform, which formalizes micro-enterprises and connects them to government schemes and collateral-free lending. As of June 2025, Udyam and Udyam Assist had registered nearly 6.5 crore enterprises, with 6.4 crore falling under the micro category.

Yet this momentum masks deeper structural issues. "Credit plays an important role in the development and scaling of MSMEs by enabling them to invest in machinery, inventory, staff, and other expansions," said Mayur Modi, co-founder, co-CEO & COO of Moneyboxx Finance. "For many small businesses, especially in Tier II, Tier III cities and rural areas, access to timely and affordable credit is often the difference between stagnation and growth."

Still, Modi doesn't see the current lending environment as adequate. "Traditional lending models often rely on collateral and formal documentation, which many of these businesses lack. Although NBFCs, fintechs, and co-lending models have improved outreach, challenges like limited risk appetite, high interest rates, and uneven digital penetration still hinder true financial inclusion," he said.

The number of active MSME loans climbed to 211.8 lakh as of March 2024, a 23.7 per cent year-on-year rise. By March 2025, that growth had tapered, with just a 1.3 per cent increase, an early sign that institutional credit may be approaching a ceiling under the current lending architecture.

Irem Sayeed, chief credit officer at UGRO Capital, sees this gap in stark numbers. "Despite the critical role MSMEs play, 75 per cent of them still rely on informal sources of credit. That reflects a 48 per cent credit gap in formal financing," she said. "Access to timely, affordable credit is often the only way these businesses can survive and scale—whether it's to fulfil larger orders, hire talent, or invest in operations."

Public sector banks remain the primary source of credit for micro businesses, with a 45.7 per cent market share as of March 2025. Meanwhile, private banks dominate lending to Small and Medium Exposure businesses, commanding nearly 50 per cent of that segment. Non-banking financial companies (NBFCs), aided by the inclusion of bank credit to NBFCs for on-lending under the priority sector lending framework, have also expanded their footprint.

However, the expansion of formal credit remains uneven. "The current lending ecosystem remains inadequate," Sayeed said. "While government schemes—like the INR 22,000 crore allocation to the Ministry of MSME, the enhancement of Mudra Tarun loans to INR 20 lakh, and credit guarantees under the RAMP and MSME Champions programs—have helped, they're not sufficient to fully bridge the gap."

She called for a stronger push from the private sector to support underserved markets: "Inclusive, flexible, and tech-enabled lending models are critical to bringing these businesses into the formal fold and unlocking their true economic potential."

While progress is evident in the rising portfolio and loan volumes, the formal system still misses a majority of MSMEs. Until lending models evolve to meet the real-world needs of these businesses, especially those outside metro hubs, India's small business engine will continue to run below capacity.