Micro, small, and medium enterprises (MSMEs) built India’s local supply chains. They account for about 30% of GDP and a large share of exports and jobs, which is why their access to formal credit matters for growth. Yet a sizeable MSME credit gap persists, keeping viable firms from restocking on time, adding outlets, or upgrading equipment. The result is uneven growth, even when demand is healthy.

This guide explains the credit gap, shows how digital lending works, and lays out where NBFCs (Non-Banking Financial Companies) can plug structural holes in the system.

Understanding the MSME Credit Gap

The MSME credit gap is the difference between what viable small firms could borrow and what they actually receive from formal lenders. The International Finance Corporation (IFC) estimated India’s addressable MSME debt gap at ₹25.8 trillion (about US$397 billion). That figure remains a useful baseline for policy and market design.

Why the gap persists

● Lack of collateral and credit history: Many MSMEs are small, lacking assets to pledge as collateral, and have inadequate or no formal credit history, making banks reluctant to lend.

● Limited financial literacy and awareness: Many MSME owners lack the financial skills and knowledge to manage cash flows or even to know about available government credit schemes, which limits their access to formal financing.

● Complex loan application processes: Documentation and approval procedures are cumbersome and time-consuming, leading many micro enterprises to avoid applying for formal loans.

● High perceived risk by lenders: Banks perceive MSMEs, especially micro and informal ones, as high-risk due to inconsistent revenues and informal operations, which discourages lending despite credit guarantee schemes.

● Informality and lack of formal registration: A significant share of MSMEs remain unregistered and informal, cutting themselves off from formal credit channels and government programmes.

The Rise of Digital Lending in India

Digital lending has shifted from branch files to mobile journeys as RBI clarified roles, data use, and borrower disclosures through the Key Fact Statement (KFS) and Annual Percentage Rate (APR). At the same time, real-time payments created verifiable cash-flow trails: UPI processed 20.01 billion transactions in August 2025 worth ₹24.85 lakh crore.

Consent-based sharing through the Account Aggregator (AA) network has cut friction further, with 2.2+ billion accounts enabled and 112.34 million users linked. These rails explain rapid adoption and the digital lending advantages MSMEs see in faster decisions and clearer pricing.

Underwriting now uses analytics on bank statements, GST returns, and UPI trails shared via AA, so lenders can score cash cycles and set limits in minutes. Mobile apps complete e-KYC, pull statements, and e-sign. AI strengthens risk signals and fraud detection across payment flows, improving accuracy at speed. These capabilities compress time to approval, a practical digital lending advantage for time-sensitive working capital.

Advantages of Digital Lending for MSMEs

Digital lending translates your routine data into faster decisions and clearer pricing. Here is how those digital lending advantages show up for MSMEs in day-to-day operations and help narrow the MSME credit gap.

1. Faster access and simpler processes: End-to-end digital workflows cut paperwork and shorten cycle times. E-KYC, statement pulls, e-sign, and standard KFS forms reduce back-and-forth, so owners can decide quickly when a supplier discount or bulk order window opens.

2. Enhanced financial inclusion: With UPI and AA adoption, more MSMEs can present clean data to lenders even without collateral, which helps narrow the MSME credit gap. India’s Financial Inclusion Index reached 67.0 in March 2025, up from 64.2 a year earlier, showing progress on access, usage, and service quality.

3. Customised credit solutions: When cash-flow data is visible, lenders can tailor limits and repayment dates to actual sales cycles. That means revolving limits for fast-moving inventory, invoice-linked finance for receivables, or term loans that match asset life. These features are central digital lending advantages because they lower the chance of cash-flow stress.

The Critical Role of NBFCs in Bridging the MSME Credit Gap

NBFCs specialise in specific customer segments, geographies, and products, and they can adjust underwriting and servicing faster than many large banks. That agility matters when trying to close a credit gap made up of millions of small, variable tickets. Industry data shows NBFC MSME portfolios have been expanding quickly, with analysts projecting continued double-digit growth and a rising share of MSME lending.

CGTMSE and Other Schemes

Collateral is a sticking point for many first-time borrowers. The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE) allows eligible lenders, including NBFCs that are Member Lending Institutions, to extend collateral-free credit with a sovereign guarantee backstop. The guarantee ceiling increased to ₹10 crore from April 1, 2025, and coverage can go up to 90% for specified categories, which expands room for MSME credit gap reduction at scale.

NBFCs also partner on receivables platforms and refinance lines that improve cost and speed for customers. As these partnerships deepen, more viable MSMEs can access formal funding on terms that match their operating rhythm.

Challenges and Opportunities for NBFCs in Digital Lending

Non-Banking Financial Companies (NBFCs) in India are rapidly adopting digital lending to bridge the MSME credit gap, but this transformation brings a unique set of challenges and opportunities ranging from regulatory compliance and risk management to leveraging cutting-edge technology and expanding financial inclusion. Some challenges include:

1. Regulatory Compliance and Transparency Mandates: The Reserve Bank of India’s digital lending guidelines, introduced since 2022, require NBFCs to maintain stringent transparency in loan terms, interest rates, and fees, as well as adhere to borrower protection norms and grievance redressal mechanisms. This increases compliance costs and requires investment in upgrading digital infrastructure and internal controls.

2. Lack of Formal Credit and Operational Data on MSMEs: A major challenge for NBFCs is assessing creditworthiness in the absence of sufficiently formal documentation, such as audited financials and stable credit history, particularly for micro and informal MSMEs. This data scarcity limits effective risk evaluation and increases the perceived risk for lenders, leading to cautious or suboptimal lending decisions. It also drives up operational costs as manual verification becomes necessary, negating some digital lending efficiencies.

3. Fraud Risk and Technology Dependence
The digital lending model exposes NBFCs to risks of document fraud, identity theft, and cyber threats, making robust cybersecurity, identity verification, and fraud detection systems imperative. Developing and maintaining these technical safeguards demands continuous investment and expertise. Operational lapses or failures in these systems can result in financial losses and reputational damage, constraining NBFCs’ ability to scale MSME lending sustainably.

On the other hand, the digital lending space comes with its own set of opportunities:

1. Utilisation of Alternative Data for Credit Underwriting: NBFCs can leverage non-traditional data points such as GST filings, mobile and digital transaction histories, and social/e-commerce platform data to more accurately assess MSME credit risk. This allows faster underwriting and extends credit to thin-file or no-file MSMEs that banks typically avoid, thereby expanding financial inclusion.

2. Last-Mile Reach and Customer Flexibility: NBFCs have the flexibility to penetrate rural and semi-urban markets underserved by traditional banks. They cater to MSMEs through localised branches, mobile-based platforms, and tailored loan products that fit informal cash flows, collateral availability, and sector-specific challenges. This last-mile connectivity, combined with simpler digital applications, makes NBFCs crucial enablers of credit access for millions of MSMEs otherwise excluded from formal credit.

The Future of Digital Lending and NBFCs in MSME Credit

NBFCs have a real shot at closing much of the MSME credit gap by pairing digital lending rails with risk-sharing programs and bank partnerships. The gap is large, but three levers change the math:

● First, consented data flows through the Account Aggregator network, letting NBFCs read bank statements and other records quickly and securely, shrinking thin-file risk and speeding cash-flow based underwriting;

● Second, guarantee backstops like CGTMSE now cover eligible collateral-free loans up to ₹10 crore with coverage up to 90% in specified cases, which encourages lending to viable firms without property security;

● Third, a unified co-lending framework gives NBFCs access to lower-cost bank balance sheets while they contribute to distribution and specialised underwriting.

Combine the above with standardised borrower disclosures (KFS/APR) and real-time payment trails, and you get practical digital lending advantages: faster approvals, sharper pricing, and limits aligned to sales cycles. Executed at scale and with responsible governance, these tools can compress and, in many clusters, effectively bridge the Credit Gap for MSMEs.

Emerging trends

The following are some trends that have been seen in the digital lending space in recent years. If these trends scale responsibly, NBFCs can help fully bridge the MSME credit gap by meeting small, frequent capital needs with data-driven products, transparent pricing, and the operational advantages of digital lending.

● Co-lending aligns bank balance sheets with NBFC speed, delivering sharper pricing and larger limits. That is a clear digital lending advantage for thin-file MSMEs.

● Embedded finance places credit inside order, billing, and payout flows, so working capital arrives at the moment of need.

● AI-powered underwriting reads consented cash-flow data to set limits, dates, and alerts that fit actual sales cycles.

Digital Lending, The Future

Digital lending has transformed how small businesses access credit by leveraging routine financial data like bank statements, GST returns, and real-time payment trails to provide lenders with clear visibility into cash flows. This enables faster loan decisions and easier price comparisons, supported by mature regulations such as consent-based data sharing through Account Aggregators and standardised borrower disclosures like the Key Fact Statement.

NBFCs play a crucial role by focusing on specific segments and geographies, offering flexible underwriting, and partnering with banks through co-lending to extend reach. Credit guarantees further enhance access where collateral is scarce. This collaborative system helps close the MSME credit gap by addressing timely, small, and frequent capital needs at transparent prices.

Progcap, as an NBFC, is doing its part in minimising the MSME credit gap through:

● Embedded, supply-chain credit. Last-Mile Retailer Financing sits inside corporate distributor networks. It gives underserved MSMEs fast, collateral-free working capital embedded right into brand-led supply chains so shopkeepers can buy inventory when they need it, digitise their transactions, build credit history, and speed up cash conversion—shifting them from informal borrowing to formal finance while boosting liquidity and sales.

● Working Capital Term Loan (WCTL): Funds can be paid straight to approved suppliers, so shelves stay stocked while operating cash covers salaries, rent, and utilities.

● Inclusion of women-led enterprises: ProgShakti pairs collateral-free working capital with training, mentorship, and a community for women-led businesses.

Learn more about the above products and more here.

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