6 Reasons for MSMEs to Enter the Formal Credit Ecosystem

• India’s MSME credit portfolio has nearly doubled in five years, reaching ₹35.2 lakh crore in March 2025, with 13.2 lakh new-to-credit MSMEs added in FY25.
• Credit-active MSMEs grew by 65% since 2020, with micro enterprises making up 92% of borrowers, showing deeper financial inclusion.
• Formal credit is crucial during the festival season, ensuring timely working capital, smooth supply chains, and sufficient inventory to meet rising demand.
• Loans from RBI-registered NBFCs like Protium offer lower borrowing costs, structured repayment options, faster digital approvals, and access to government-backed schemes.
• Entering the formal credit ecosystem builds resilience—improving repayment history, strengthening supplier trust, and enabling MSMEs to graduate to higher-value loans.

The commercial credit portfolio for MSMEs has nearly doubled in five years, growing at a 13% compounded annual growth rate (CAGR) and reaching ₹35.2 lakh crore by March 2025. This highlights that more MSMEs are moving into formal financial channels, supported by digitization, targeted policies, and government-backed schemes. The entry of 13.2 lakh new-to-credit MSMEs in FY25, which means over half of all first-time borrowers, further marks a significant shift towards financial inclusion. It indicates that small enterprises are increasingly choosing formal credit over informal borrowing. So much so that between March 2020 and March 2025, the number of credit-active businesses surged by 65%. Also, 92% of these belong to the micro category.

Building on this momentum, distinct growth patterns are visible across borrower segments.

• Micro enterprises recorded a 12% CAGR, reaching an outstanding portfolio of ₹8.3 lakh crore in March 2025.
• Business in the Small category grew at a 14% CAGR and expanded at a 33% CAGR over the last five years.
• Medium enterprises have maintained a steady growth at 13% CAGR, with lower default levels, highlighting their stability.

The repayment trend has been equally promising. Overall defaults have fallen to 1.8% in March 2025, nearly by half, from 3.9% in 2019. This demonstrates stronger credit behavior and makes financial institutions more open to formal MSME lending.

The progress can be attributed to digitization, GST-linked data, and the Udyam registration system, which allow lenders to assess business stability more accurately. This formalization of their financial footprint gives MSMEs access to affordable capital but also builds credibility with institutional lenders.

The demand for goods and services is all set to peak with the festival season. Entering the formal credit ecosystem will especially hold small businesses in good stead as higher sales potential requires timely working capital, efficient supply chains, and the ability to stock inventory. Access to reliable, affordable, and formal credit is the foundation for meeting these seasonal demands without financial stress.

Why Formal Credit Matters for MSMEs

Many MSMEs still rely on informal lending sources such as friends, relatives, or local moneylenders. While these options may appear quick, they often come with high interest rates, lack of structured repayment schedules, and no contribution to a business’s financial history. Over time, this reliance can trap enterprises in cycles of debt without enabling growth.

To overcome these challenges, MSMEs need to gradually shift toward formal lending channels. Unlike informal credit, formal finance is designed not only to meet immediate funding needs but also to support long-term stability. By entering the formal system, small enterprises can access affordable capital, strengthen their business credibility, and prepare for expansion. Formal credit offers several other advantages:

• Lower borrowing costs: Loans from banks and RBI-registered NBFCs like Protium carry regulated interest rates and flexible repayment options, which are generally much cheaper than informal sources.
• Structured products and longer tenures: MSMEs can access cash credit, overdrafts, term loans, and property-backed loans that provide repayment flexibility.
• Credit history building: Consistent repayments strengthen the CIBIL MSME Rank (CMR), enabling businesses to qualify for larger loans or top-up facilities in the future.
• Faster approvals through digitization: With GST, PAN, and Udyam-linked data, loan processing has become quicker and more transparent.
• Access to government-backed schemes: Programs like PM Mudra Yojana, CGTMSE (Credit Guarantee Fund Trust for Micro and Small Enterprises), and SIDBI’s specialized offerings are tied to formal credit, making it essential for MSMEs to be part of the formal system.
• Availability of top-up loans: Once MSMEs establish a repayment track record, lenders often provide quick top-ups on existing loans. This ensures access to additional working capital during peak demand seasons without undergoing the full loan application process again, saving time and maintaining business continuity.

How MSMEs Can Enter the Formal Credit Ecosystem

The transition into formal credit requires deliberate actions. MSMEs can position themselves better by following these steps:

1. Formal Registration and Compliance

Registering on the Udyam portal is the first step for recognition as an MSME. As of early 2025, more than 5.7 crore MSMEs have registered under Udyam and Udyam Assist. Coupled with GST compliance and valid PAN details, these registrations establish business identity and credibility. Lenders view compliance as proof of stability, making it easier to approve loans.

2. Building a Transaction Trail via Banks

Consistent financial transactions through current accounts help create a reliable business trail. Using digital payments, depositing sales revenue, and managing expenses via banks reflect operational health. For lenders, this bank trail is often the primary document for credit appraisal. MSMEs should avoid excessive cash dealings and move towards traceable transactions.

3. Maintaining Proper Financial Records

Systematic bookkeeping, audited statements, and digital invoicing improve transparency. Financial records not only highlight profitability but also signal repayment capacity. Many MSMEs struggle with loan approvals because their records are either incomplete or informal. Investing in proper accounting practices pays off by improving creditworthiness.

4. Adopting Digital Tools for Financial Management

Digital adoption has become a defining factor in credit access. Tools such as e-invoicing, GST-linked compliance, UPI transactions, and digital billing systems create authentic records. These records help lenders assess repayment capacity and cash flow discipline. For MSMEs, digital tools also reduce errors, improve efficiency, and provide real-time visibility into financial health.

The Direct Outcomes and Benefits of Formal Credit Access

The advantages of entering the formal credit ecosystem go well beyond immediate borrowing, as they enable MSMEs to achieve sustained growth and resilience. Access to credit supports business expansion by allowing enterprises to invest in machinery, hire workers, and adopt new technologies, with many businesses that graduate to higher credit segments holding multiple credit products, which is an indicator of financial maturity. 

During high-demand periods such as the festive season, timely working capital ensures that MSMEs can maintain adequate stock, raw materials, and manpower, reducing the risk of stockouts or losing customers to larger competitors. Formal credit also strengthens negotiation power, as financially backed businesses are better positioned to secure favorable terms from suppliers and distributors. Most importantly, consistent use of formal loans builds a reliable credit history, enabling MSMEs to scale over time. For instance, 11% of MSMEs transitioned into higher credit categories within just 24 months, led largely by manufacturing enterprises, which proves growth potential and long-term resilience.

The MSME credit landscape in India is undergoing rapid transformation. With commercial credit portfolios growing, delinquency levels falling, and millions of first-time borrowers entering the system, the opportunity for small enterprises to access reliable finance has never been greater. For MSMEs in Tier-2 and Tier-3 cities, the path is clear. Formal registration, disciplined transactions, strong repayment behavior, and digital adoption are the building blocks for accessing structured credit. As festive demand rises and growth opportunities expand, entering the formal credit ecosystem is the surest way for MSMEs to secure sustainable success.

 SIDBI and TransUnion CIBIL, MSME Pulse June 2025 report