The overall credit to micro, small and medium enterprises (MSMEs) which stood at Rs. 16 trillion as in March 2017 is  expected to pick up and grow at 12-14% over the next five years. According to an ICRA note, this growth will be powered by non-banks (non-banking finance companies and housing finance companies), which are expected to expand at about 20-21% CAGR in this space. On the other hand, bank credit to this segment, which accounted for about 84% of total MSME credit, is estimated to grow at a lower CAGR of 9-11% during the same period.

A. M. Karthik, Assistant Vice President and Sector Head, Financial Sector Ratings, ICRA, said,  ''Non-banks' share in the MSME credit pie should expand to 22-23% by March 2022 compared to 16% in March 2017. Non-banks, with their niche positioning, differentiated product offering, good market knowledge and large unmet demand, would be able grow at a healthy rate vis-à-vis banks.''

With large corporate credit expected to remain sluggish, at least over the next 1-2 years, ICRA expects bank credit to this segment to be around 9-11% with public sector banks growing at 7-9% and private banks at 16-18%.

''There is large unmet credit demand in this segment, which we estimate to be about Rs. 25 trillion in FY2017. Notwithstanding the estimated growth, the unmet credit demand quantum is likely to increase further, going forward,'' added Karthik.

While demonetisation and the implementation of the GST has had an impact on the segment's performance, ICRA expects that the various initiatives taken, including the removal of the lending cap for priority sector classification, access to credit subsidy and guarantee schemes and setting up of institutions like MUDRA etc, would channel credit flow to the MSME segment.   

Asset quality has weakened for all lender categories in a steady manner. Banking NPAs in the micro and small enterprises (MSEs) segment stood high at about 8.4% in March 2017 while that of non-banks stood at about 3.0% as on that date. Notwithstanding the moderate seasoning of the portfolio, non-banks have a more flexible and customised credit assessment for this segment and have steadily been moving to lower ticket loans, in view of the asset quality pressure in the large ticket loans and better yields in the smaller ticket loan (<Rs. 10 million) categories. Thus, while  non-bank asset quality is expected to worsen from current levels, the extent of deterioration may be lower than that witnessed in banks.

Increased competitive pressure and asset quality moderation has affected segmental profitability for non-banks. Business yields have moderated quite sharply over the last two to three years (about 2.0-2.5%) with the entrance of new players. The ability to diversify and scale up smaller ticket loans, without impacting operating efficiencies and credit costs, would be crucial for their incremental profitability.