Whalesbook
NBFCs Gain Ground in Lending
India's small business credit market has seen significant growth, reaching ₹47.8 lakh crore by December 2025. This expansion signals a fundamental change in lending dynamics, supported by economic stability and government policies that are making financial services more accessible.
Non-banking financial companies (NBFCs) are now a major force, holding 28% of the small business loan market as of December 2025, up from 26.8% a year earlier. This growth is particularly strong in loans for sole proprietors, where NBFCs account for 41.6% of outstanding loans. While banks traditionally focused on larger businesses, NBFCs have shown much faster average annual growth in MSME lending (32% from FY21-FY24) compared to private banks (20.9%) and public sector banks (10.4%). NBFCs dominate small property-backed loans under ₹10 lakh, holding 45% of this segment. This shows NBFCs are strategically targeting smaller, secured loans to reach more borrowers. Despite potential pressure on lending margins and higher credit costs, NBFCs are expected to grow MSME lending by 20% in FY26. The co-lending model helps them use banks' lower funding costs while leveraging their own wide reach.
Sole Proprietors Drive MSME Loan Growth
Sole proprietors are the backbone of this market, making up nearly 80% of outstanding loans and 73% of borrowers. Loan approvals rose 13.3% year-on-year by December 2025, with sole proprietor loans growing even faster at 15%. The pool of borrowers is also diversifying: women represented 23.9% of new loans, and younger borrowers (under 35) are a key source of demand. The average loan size for sole proprietors stayed steady at ₹3.34 lakh. More businesses are formalizing their finances, with new-to-credit (NTC) borrowers accounting for 23.3% of sole proprietor loans. Borrower risk profiles are improving, with a larger share of low-risk clients now seen for both sole proprietors and other businesses.
Credit Expands to Smaller Cities and Districts
Credit is now reaching beyond major cities. While top states hold about 72% of loans, lending in smaller cities (BT100) now makes up nearly 40% of sole proprietor credit. Financially developing "aspirational districts" saw credit grow 18.4% to ₹3.2 lakh crore, outpacing the market. These areas also showed improving credit quality, with overdue loans getting closer to national averages. In Gujarat, small business loans grew 11.8% to ₹3.9 lakh crore, with better asset quality than the national average: only 0.9% of loans were overdue by 91-180 days, compared to 1.3% nationally. This wider reach into smaller cities and developing districts shows a more inclusive credit system.
Potential Risks and Challenges Ahead
Despite strong growth, several risks need attention. Relying more on NBFCs expands access but brings vulnerabilities. Smaller NBFCs often pay more for funding, using costly options like selling loans or issuing bonds, which carries risks when they need to refinance. This divided access to funding could lead to fewer, larger players dominating the market. While overall credit quality is stable, small property-backed loans (micro-LAP) within NBFCs show higher rates of overdue loans (PAR90+) compared to larger loans, suggesting stress in the smallest loan sizes. A growing number of new-to-credit borrowers, while positive for formalization, could pose a risk if their ability to repay isn't carefully checked, especially if global interest rates change. The Reserve Bank of India has noted potential risks from microfinance and unsecured loans spilling into property-backed portfolios. Even though Indian SMEs might be less sensitive to interest rate changes due to government support and public banks, higher global rates could still affect loan affordability and default rates. Lending to sole proprietors also presents unique loan approval challenges because they often have less formal financial records than larger companies. Any future tightening of regulations on NBFCs or changes in interest rate policy could also challenge ongoing credit growth.
Outlook for MSME Credit
India's small business credit market is expected to keep growing and improve financial inclusion. The shift towards NBFCs is likely to continue, thanks to their flexibility and focus on specific market segments. Increased formalization of credit, more new-to-credit borrowers, and better risk profiles suggest a stronger financial system. The ongoing expansion into semi-urban, rural, and aspirational districts highlights a commitment to wider economic growth. Analysts expect MSME lending to remain a key driver of credit expansion in 2026, supported by government programs and updated loan approval methods.