Social Capital Challenges faced by MSMEs in Accessing finances – We must bank on social capital

Source: The post Social Capital Challenges faced by MSMEs in Accessing finances has been created based on the article “We must bank on social capital” published in “Business Standard” on 18^th December 2023.

Syllabus Topic: GS Paper 3, Indian Economy, Industries and Industrial policies

News: The article provides historical context to the present finance challenges faced by the Indian entrepreneurs and MSME (Micro, Small & Medium Enterprises) sector.

What is social capital?

“Social capital” is defined as the capital or resources we gain from staying within a social network. It includes networks of relationships among people who live and work in a particular society, enabling that society to function effectively.

What hindered industrial development before independence?

Mahadev Govind Ranade mentioned in his 1890 speech at the first Industrial Conference in Pune about the scarcity of capital for industry in India due to the hoarding of bullion and the absence of financial institutions.

Ranade pointed out that there is a locking up of capital in unproductive assets like gold and land due to a lack of institutional arrangements for industrial finance. It hindered industrial development at that time.

Reason: One of the reasons behind this was social capital constraints arising from hyper-diversity, where capital stayed within caste-community groups. A caste-community only invested in their own community people. The excess finances were invested in unproductive assets, like land and gold. Other well-known reason is lack of development of financial institutions by British.

In comparison, during Meiji era, Japan was successful in gathering small savings and channeling them into the mainstream of the national economy, which greatly facilitated its industrialization process.

What are the present challenges of access to finances for MSMEs?

A century later, historian Dietmar Rothermund also noted the absence of financial institutions in 19th-century India. It is in contrast with Japan’s successful channeling of small savings into national economic development.

First, a substantial credit gap exists in the MSME sector. Estimates suggest that only a small fraction of enterprises have access to formal credit, with the majority relying on informal sources. As per Avendus Capital the MSME credit gap is estimated at around $530billion. Only 14% of 64 million enterprises have access to formal credit.

Second, over 99% of the MSME sector comprises micro-enterprises, around 80% of which borrow from informal sources, like friends and family.

Third, Trust within one’s community continues to play a pivotal role in investment decisions, especially in informal sources of investment.

Fourth, Public sector financial institutions have somewhat reduced caste bias in capital allocation, particularly in agricultural loans. However, disparities remain in business loans, indicating that social capital and community networks still influence financial decisions.

Fifth, as per some studies, an entrepreneur from a non-dominant group will find it harder to succeed in a new business because she lacks a network.

What should be done?

Caste-based identity politics can further entrench these divisions, strengthening within-community bonds while weakening inter-community financial cooperation. Therefore, it should be avoided.

Open Credit Enablement Network (OCEN) can function as a potential technological solution. Its aim is to transcend caste and community biases, enabling a more equitable distribution of business credit across India. This aligns with Ranade’s vision of a financially inclusive and industrially robust India.