The Role of Credit Scores in MSME Financing

Micro, small, and medium enterprises (MSMEs) form the nerve of India’s economy by spurring industrial growth, generating employment opportunities, and fostering innovations within various sectors. Nevertheless, MSMEs still face a glaring difficulty in acquiring loans for their businesses.

For any borrower seeking a loan, credit rating remains a fundamental consideration by lenders. This article explores the role of credit scores in MSME financing, focusing on their importance, impact, and ways to improve them.

Understanding Credit Scores

A credit score is a three-digit number that reflects an individual's or business's creditworthiness. In India, the Credit Information Bureau (India) Limited (CIBIL) provides these scores, ranging from 300 to 900. A higher score indicates great credit health.

Importance of Credit Scores in MSME Financing

• Loan Approval: Lenders assess credit scores to determine the risk associated with lending. A higher score increases the likelihood of loan approval.
• Interest Rates: MSMEs with good credit scores often receive loans at lower interest rates, reducing the cost of borrowing.
• Loan Amounts: A strong credit score can lead to approval for higher loan amounts, facilitating business expansion.

Also Read: Why is Credit Score Important for Loans?

Minimum Credit Score Requirements for MSME Loans

While requirements vary among lenders, a CIBIL score of 700 and above is generally considered good for MSME loans. Some institutions may accept scores as low as 650, but this could result in higher interest rates or stricter terms. For instance, NBFCs typically consider a minimum CIBIL score of 685 for MSME loan applications.

Factors Affecting Credit Scores

• Payment History: Timely repayment of existing loans boosts credit scores.
• Credit Utilization: Maintaining a low balance relative to the credit limit positively impacts the score.
• Credit History Length: A longer credit history provides a clearer picture of financial behaviour.
• Credit Mix: A diverse mix of credit types, such as term loans and credit cards, can improve the score.

Tips for Improving Credit Scores for Better MSME Financing Options

• Timely Payments: Ensure all loan repayments and credit card bills are paid on time.
• Limit New Credit Applications: Frequent applications can negatively affect the score.
• Monitor Credit Reports: Regularly check for errors in credit reports and rectify them promptly.
• Maintain Low Credit Utilization: Keep credit utilization below 30% of the available limit.

Also Read: What Can You Do To Improve Your Credit Score

Government Initiatives Supporting MSME Financing

The Indian government has introduced schemes to aid MSME financing:

• Credit Guarantee Scheme: Announced in July 2024 during the Union Budget presentation, this scheme helps manufacturing-focused MSMEs purchase machinery without requiring collateral. It provides a guarantee cover of up to INR 100 crore per applicant.
• MUDRA Loans: The Micro Units Development and Refinance Agency provides loans up to INR 20 lakh to micro and small enterprises, supporting business growth.

The Bottom Line

Credit scores play a pivotal role in MSME financing in India. They influence loan approval chances, interest rates, and the amount of credit extended. MSMEs should prioritize maintaining a healthy credit score to access favorable financing options. Regular monitoring and responsible credit behavior are essential steps toward achieving this goal.

If you're an MSME seeking financing, apply for a business loan to advance your development. For this, understanding your credit score is crucial. Take proactive steps to improve it and explore the various loan options available to support your business growth.

Moreover, the Godrej Capital loan calculator can help you analyze monthly instalments and fulfil your financial goals.

FAQs

Q.1. Why is credit rating important for MSMEs?

A. A good rating enables MSMEs to access funds through loans at cheaper rates and better terms. It also betters the acceptability of the MSMEs with their customers by indicating their financial stability and creditworthiness.

Q.2. What is the role of credit scoring?

A. Credit scoring is a statistical analysis performed by lenders and financial institutions for the borrower. This determines the borrower’s creditworthiness and helps lenders decide whether to give out a loan or deny it.

Q.3. What is the role of credit rating in the financial market?

A. Credit ratings are essential not only for prospective investors but also for the entities that they rate. A high credit rating can give a company access to the capital it needs at interest rates it can afford. A low credit rating can mean the borrower must pay higher interest rates.

Q.4. What is the role of credit in finance?

A. Credit can be a powerful tool in achieving important financial goals by allowing businesses to afford inventory, spend on development or expand their business.

Q.5. How is credit score beneficial to investors?

A. Credit ratings help investors assess the credit risk of investments and evaluate default probabilities. This aids in an informed decision-making process, keeping one’s financial goals in mind.

Disclaimer:

The contents of this article are for information purposes only and not a financial advisory. The information is subject to update, revision, and amendment and may change materially. The information is not intended for distribution or use by any person in any jurisdiction where such distribution or use would be contrary to law or regulation or would subject Godrej Capital or its Affiliates to any requirements. Godrej Capital or its Affiliates shall not be responsible for any direct/indirect loss or liability incurred by the reader for making any decisions, financial or otherwise based on the contents and information mentioned. For more information, please visit www.godrejcapital.com.