In a notable shift in the Indian credit landscape, Micro, Small and Medium Enterprises (MSMEs) have emerged as the fastest-growing segment of bank lending in FY2024-25, surpassing even traditionally robust segments like retail and services credit. According to the latest data from the Reserve Bank of India (RBI), MSME loan growth clocked 14.1% year-on-year, outpacing retail loans at 11.7% and services at 11.2%.

This resurgence in MSME credit highlights a fundamental shift in the credit deployment priorities of banks, signaling both improved borrower confidence and a stronger ecosystem supporting small businesses.

MSME Loan Book Reaches Record Levels

By the end of May 2025, the outstanding bank loans to MSMEs surpassed ₹14,30,000 crore (US$ 167.06 billion). The share of MSME credit in overall bank lending touched a record 17.7%, reflecting a structural uptick in the financial inclusion of India’s business backbone.

This trend is particularly remarkable given the backdrop of a general slowdown in overall bank credit across sectors. In contrast, the MSME segment has sustained consistent growth, driven by targeted government support, improving credit discipline, and refined credit underwriting practices.

Improved Asset Quality: A Positive Signal

One of the key enablers of this MSME credit expansion is the steady improvement in asset quality. The gross Non-Performing Asset (NPA) ratio for MSME loans has dropped from 4.5% in March 2024 to 3.6% by March 2025, marking a significant recovery and improved financial health across the sector.

This is supported by a marked decline in the share of subprime borrowers, which fell from 33.5% in June 2022 to 23.3% in March 2025. The subprime category includes borrowers with lower creditworthiness and a history of repayment risk. The decline implies better borrower behavior and stricter credit assessments.

Additionally, the Special Mention Account-2 (SMA-2) ratio—which tracks accounts overdue by 60–90 days, a crucial early warning indicator—dropped to just 0.8% of total MSME credit. This suggests lower slippage risk and higher portfolio stability, giving banks greater confidence in scaling up credit disbursal to this sector.

Segment-wise Growth: SMEs Lead the Pack

Within the MSME universe, small and medium enterprises (SMEs) have outperformed micro enterprises in terms of incremental loan growth. This indicates a maturing credit appetite from entities that are scaling operations, investing in capacity, or entering new markets.

While micro enterprises remain integral to the rural and informal economy, the SME segment is increasingly playing a key role in exports, manufacturing, and B2B services, making them attractive to commercial lenders.

Role of Government Credit Guarantee Schemes

Much of this credit momentum has been enabled by government-backed credit guarantee mechanisms, which have significantly de-risked bank lending to the MSME sector.

Two schemes in particular have played a pivotal role:

1. Credit Guarantee Fund for Micro Units (CGFMU)

   • Total coverage: ₹6,28,000 crore (US$ 73.38 billion)

   • NPA Ratio: 10.8%

2. Emergency Credit Line Guarantee Scheme (ECLGS)

   • Rolled out during COVID-19 to support liquidity

   • NPA Ratio: 5.6%

While these schemes have proven effective in expanding credit outreach, especially for first-time and vulnerable borrowers, their relatively higher NPA ratios reflect the underlying risk profile of the segments they serve. These figures underscore the importance of risk-sharing mechanisms in supporting credit access without impairing bank balance sheets.

Why Banks Are Turning to MSMEs

The renewed focus on MSME lending is driven by several interlinked factors:

• Retail loan saturation in urban markets

• Improved credit behavior and formalisation of MSME borrowers

• Digitisation of credit assessment through platforms like PSB Loans in 59 Minutes

• Expansion of credit bureaus and alternate data usage

• Government push through PLI schemes, GST input credits, and TReDS platforms

Furthermore, with corporate credit demand still subdued, and retail loans facing rising delinquency risks in unsecured personal loans, banks are actively diversifying into MSME credit to optimise asset quality and profitability.

Policy and Regulatory Backing

The RBI and the Government of India have provided strong policy support to MSMEs over the past three years, including:

• Revised MSME classification norms, widening the eligibility pool

• Interest subvention schemes to reduce the cost of capital

• GST-linked working capital loans for timely liquidity

• Digital trade finance platforms for invoice discounting and payments

The Budget for FY25 also included enhanced allocations for SIDBI refinance and credit-linked capital subsidies, reinforcing the long-term policy intent to support MSMEs as the bedrock of India’s economic growth.

Challenges Ahead

Despite the impressive momentum, there are challenges that remain:

• Dependence on government guarantees needs gradual phasing out to ensure market sustainability.

• Sectoral concentration risks in MSME lending, particularly in real estate-adjacent industries, need monitoring.

• Limited formal documentation for many micro enterprises continues to hamper credit assessment.

• Digital infrastructure and financial literacy remain weak in some rural areas.

To address these issues, policymakers are expected to fine-tune risk-sharing models, encourage co-lending frameworks, and improve access to alternative financing instruments like invoice discounting, revenue-based financing, and equity support via fund-of-funds.

Outlook: MSMEs as Growth Catalysts

The 14.1% credit growth in MSMEs, coupled with improving asset quality, suggests a positive inflection point for the sector. Banks are increasingly viewing MSMEs as sustainable, long-term borrowers, rather than high-risk entities.

With continued policy support, maturing digital lending infrastructure, and stronger institutional mechanisms, the MSME sector is poised to become the single largest driver of inclusive economic growth and employment in India.

Conclusion

The rise of MSMEs as the primary engine of credit growth in FY25 marks a strategic evolution in India’s credit ecosystem. From being considered risky and underserved, the MSME segment is now central to bank loan portfolios, thanks to better underwriting, stronger support systems, and formalisation.

As the sector continues to expand its economic footprint, the synergy between banks, government, fintechs, and guarantee institutions will be key to building a resilient, innovation-driven, and inclusive economy.

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