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Micro, small, and medium enterprises (MSMEs) form the backbone of India’s economy as they contribute 37.5% to the GDP, and are also fundamental to the nation’s development as they employ lakhs of unskilled and semi-skilled individuals. The government aims to increase this contribution to 50%.

According to the IBEF report, presently there are 633.9 lakh MSMEs in India, with 99% of them being micro-enterprises.

Despite the sector’s contribution, MSME financing in India remains a critical issue. The sector faces challenges owing to an absence of credit history, low awareness about government schemes, insufficient collateral, and high interest rates. These challenges have made it difficult for MSMEs to secure financing, which has hindered the sector’s growth and development. This lag is being filled in by non-banking financial companies (NBFCs). Most MSMEs are now looking up to RBI-registered NBFCs for their financial needs because of their regulatory compliance and trustworthiness.

The role of RBI in NBFC regulation

The RBI plays a crucial role in fostering a well-regulated environment for NBFCs in India. These NBFCs, distinct from traditional banks, provide a broad spectrum of financial services, including loans, advances, and asset finance, contributing significantly to the financial sector’s vitality. In recent years, there has been a notable shift towards strengthening the regulatory landscape for NBFCs, with the RBI proposing new regulations to enhance their asset-liability and risk management frameworks.

The RBI has effectively established a robust regulatory framework designed to comprehensively oversee NBFCs, with a primary focus on ensuring their stability, transparency, and reliability. This framework serves as a testament to the RBI’s dedication to cultivating a secure and accountable financial environment.

One of the primary reasons why MSMEs prefer RBI-registered NBFCs is the assurance of stringent adherence to regulatory norms. These norms encompass various facets, including risk management, liquidity management, corporate governance, capital adequacy, and disclosure requirements. The RBI diligently monitors and oversees the operations of these NBFCs, periodically conducting assessments and audits to verify their compliance with regulatory standards. This proactive approach not only safeguards the interests of MSMEs but also contributes significantly to the overall trust and confidence in the Indian financial sector.

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Compliance ensures financial stability

Financial stability is crucial for MSMEs looking for lending partners. RBI-registered NBFCs are required to maintain a certain level of capital adequacy, which acts as a safety net against unforeseen financial shocks. This capital cushion enables them to absorb losses and continue their operations without compromising their ability to meet obligations towards borrowers, including MSMEs.

Transparency and accountability

Transparency and accountability are the foundational pillars of trustworthiness. The RBI’s regulations confirm that NBFCs uphold transparency in their operations and offer precise information to stakeholders, including borrowers. MSMEs prefer to work with NBFCs that reveal their terms and conditions transparently, facilitating businesses to make informed decisions regarding loans and financial products.

The RBI’s requirement for regular financial reporting and disclosures further infuses clarity in the sector. RBI-registered NBFCs must submit various reports, such as the Annual Financial Inspection Report, to the central bank with comprehensive details on their financial health and compliance with regulatory norms.

Risk management

Effective risk management is crucial for the stability of financial institutions. The RBI mandates that NBFCs have robust risk management frameworks in place to identify, assess, and mitigate various types of risks, including credit risk, liquidity risk, and operational risk. This requirement ensures that MSMEs working with these NBFCs are exposed to lower risks, as these companies have a structured approach to managing potential challenges.

Accessibility and customisation

MSMEs often require financial solutions that are tailored to their specific needs. RBI-registered NBFCs, while subject to regulatory constraints, still have more flexibility in structuring their products and services compared to traditional banks. This flexibility allows them to design financing options that cater to the unique requirements of MSMEs.

For instance, many RBI-registered NBFCs offer customised working capital loans, invoice financing, and trade finance solutions that are well-suited for MSMEs. These offerings help MSMEs manage their cash flows effectively and fuel their growth.

Picking the right financial partner is an important decision for MSMEs in India. There has been a noticeable surge in the number of these businesses that have opted to work with RBI-registered NBFCs due to the trustworthiness and regulatory compliance of these institutions.

(Parry Singh is the Founder and CEO of Red Fort Capital.)