V Anantha Nageswaran, chief economic advisor to the Indian government, has emphasized the urgent need to revise non-performing asset classification norms for MSMEs, as reported by SME. He highlighted that existing norms ignore diverse cashflow cycles and working capital needs, noting that a uniform global framework does not suit Indian business. This government intervention comes as MSMEs face continued challenges in asset quality improvement, with the micro segment requiring particular attention due to its significant contribution to India's economic growth.
While overall asset quality across sectors has improved since pre-pandemic levels, bad-loan ratios for micro enterprises have stagnated, according to reports from Business Standard. The micro segment, which accounts for 84.4% of active MSME credit accounts, trails both small and medium enterprises in asset quality metrics. Between FY19 and FY25, the gross non-performing asset ratio for the wider industry dropped by 17.13 percentage points, while MSMEs improved by 8.11 percentage points. The industry started from a far higher base and moved below MSMEs in FY24, staying lower in FY25.
Within MSMEs, micro enterprises have gained the least improvement in asset quality. According to detailed data from Q2 FY21 to Q3 FY26, their bad loans declined by just 0.6 percentage point during this period. By contrast, small and medium enterprises showed considerably better performance, widening the gap with micro enterprises. In Q2 FY21, the bad loan ratio of micro enterprises was only 0.1 percentage point higher than small enterprises, but by Q3 FY26, the gap had widened to 1.1 percentage points. Compared to medium enterprises, micro enterprises had a ratio 0.8 percentage point lower in Q2 FY21, but it rose to 1.5 percentage points higher in Q3 FY26.
The performance of different lender types shows stark variations in MSME lending. As reported by Business Standard, non-banking financial companies (NBFCs) had the weakest record among lenders serving MSMEs for much of the period, with their bad loans staying below those of public-sector banks (PSBs) for six straight quarters from Q1 FY24 to Q2 FY25. However, gains did not last, with the two ratios becoming equal in the next quarter. Since Q4 FY25, NBFCs' bad loans have edged up, peaking at 2.7% in Q2 FY26, making them the riskiest lender. By contrast, PSBs have improved further to 2%, while private banks remain the safest at 1.1%.
A recent SIDBI report on MSMEs reveals significant challenges in credit access, according to Business Standard reports. The study found that one in eight micro enterprises depends on informal credit, while small and medium enterprises largely use formal sources. Only 68% of micro enterprises had access to formal credit, against 85% of small and medium ones. One in four entrepreneurs also reported difficulty in obtaining credit, highlighting the structural barriers facing micro enterprises in accessing formal financial services. This credit gap explains part of the asset quality challenges facing the micro segment, as they rely more heavily on informal financing sources.
