SME Credit: Too Political to Fail, Too Risky to Fund

Few complaints in Indian economic policy are as persistent, and as misleading, as the claim that “SME credit is not picking up.” It appears after every Budget, in industry memoranda, RBI speeches, and parliamentary debates with ritualistic regularity. Each time, the implication is familiar: banks are not doing enough.

But after decades of schemes, guarantees, restructurings, and exhortations, the more relevant question is not why SME credit is the way it is, but why we pretend not to understand the reasons.

The uncomfortable truth is that SME financing in India sits at the intersection of politics, prudential regulation, and institutional fear. Credit is not stalled because instruments are missing. It is stalled because the system has been designed to generate credit headlines without credit accountability.

Small and medium enterprises have never lacked policy attention. Priority Sector Lending mandates, Mudra loans, CGTMSE guarantees, the Emergency Credit Line Guarantee Scheme, repeated restructuring windows, and now fintech partnerships; SMEs are arguably one of the most “schemed” segments of Indian finance.

Headline MSME credit numbers have periodically improved, especially during episodes of regulatory forbearance or sovereign guarantees. But beneath these aggregates, the risk-adjusted, organic flow of bank credit to genuinely productive SMEs remains uneven. Public sector banks, which dominate SME lending, got a reason to be particularly cautious.

This caution is often misread as hostility. In reality, banks frequently encounter borrowers who fragment cash flows, maintain parallel banking relationships, and resist full revenue routing, then complain that credit limits are not enhanced. This behaviour is not paradoxical. It is rational in a distorted incentive environment.

Only Banks on Trial
A basic inconsistency runs through the SME credit debate: if SME lending is structurally unviable, why do complaints arise only against banks?

NBFCs, fintech lenders, private credit funds, trade financiers, and factoring platforms actively lend to SMEs, often at higher rates, shorter tenors, and tighter covenants. They do so without priority-sector mandates, without moral suasion, and without periodic policy exhortations. Defaults are priced in. Failure is expected. Enforcement is integral.

There are no public campaigns demanding that NBFCs “do more for SMEs.” No parliamentary rebukes when private credit retreats. The silence is revealing.

Non-bank credit operates on contract, not entitlement. SMEs may resent the cost, but they accept the legitimacy of the terms. That acceptance evaporates only when credit is channelled through public-sector balance sheets.

Banks do not “misunderstand” SMEs; they resist opaque risk. Employment goals belong in fiscal policy, not bank pricing. High NBFC rates reflect real risk, not apathy. And firms that list on stock exchanges cannot credibly reject market discipline in credit. The dispute is not about access; it is about accountability.

Bank-oriented SME credit in India is no longer treated as a commercial decision. It is treated as a political entitlement.

SMEs are portrayed simultaneously as engines of employment, symbols of self-reliance, and victims of corporate concentration. This makes them electorally sacrosanct. Any slowdown in credit is framed as banker indifference or institutional neglect, rarely as a reflection of borrower risk, weak cash flows, or sectoral stress.

This politicisation creates a fatal asymmetry. Lending is encouraged loudly. Pricing risk is discouraged quietly. Failure is tolerated rhetorically but punished institutionally.

Banks respond predictably. Targets are met. Schemes are utilised. Conviction is absent.

The binding constraint on SME credit is not ideology—it is experience.

For public sector banks, SME loans have historically been among the most difficult assets to resolve: too small for efficient insolvency, too numerous for bespoke attention, and too politically sensitive for decisive enforcement.

Large corporate NPAs eventually found resolution pathways. Retail NPAs diversified away with scale. SME NPAs lingered, dragging profitability, inviting audit scrutiny, and generating vigilance anxiety.

Once an SME account turns stressed, recoveries are slow and restructurings are demanded. The banker’s payoff matrix is skewed: limited upside, unlimited downside. Risk aversion, in this context, is rational.

Market Contradiction
The entitlement logic weakens further in capital markets. India has created a dedicated SME exchange platform with relaxed norms and lower listing costs. Hundreds of SMEs have raised equity.

But listing assumes something fundamental: that the firm stands on its own business proposition, generates shareholder value, discloses transparently, and accepts failure as a possibility. No one argues that listed SMEs deserve protection because employment is at stake.

You cannot celebrate market discipline in equity markets while rejecting it in credit markets.

The real question is not why SME credit is slow.

It is whether SME credit is meant to be a banking decision or a political programme.

Until that question is answered honestly, banks will try to hedge, SMEs will protest, and policymakers will announce new schemes to correct distortions created by the old ones. After all, credit will flourish where risk is priced and remain scarce where it is denied.