In 2018, the RBI's Expert Committee on MSMEs — chaired by former SEBI chairman U.K. Sinha — toured the country and heard the same complaint from small business owners everywhere: banks counted medium enterprises toward their MSME targets, claimed compliance, and left the smallest businesses unfunded. A garment workshop in Tirupur with ten employees and a pharmaceutical company in Hyderabad with five hundred were both "MSMEs" on paper. The bank preferred the pharmaceutical company. The workshop got nothing.
That asymmetry is why every bank branch in India now carries a separate micro-enterprise lending target — not just a general MSME bucket, but a ring-fenced 7.5% of Adjusted Net Bank Credit that must reach micro enterprises specifically. The story of how that target came to exist, and the infrastructure built around it, runs through two decades of definitional changes, guarantee schemes, receivable platforms, and emergency interventions.
What changed when "small scale industry" became "MSME"?
The foundation shifted on 16 June 2006 when the Government enacted the Micro, Small and Medium Enterprises Development (MSMED) Act. The RBI's circular of 4 April 2007 (Credit flow to Micro, Small and Medium Enterprises) formally adopted the new definitions for bank lending purposes. Before this, the category was "small scale industry" — an investment-in-plant-and-machinery test capped at Rs 1 crore. The MSMED Act created three tiers: micro (investment up to Rs 25 lakh for manufacturing), small (up to Rs 5 crore), and medium (up to Rs 10 crore).
"The Government of India has since enacted the Micro, Small and Medium Enterprises Development (MSMED) Act, 2006 on June 16, 2006 which was notified on October 2, 2006. Consistent with the notification of the Micro, Small and Medium Enterprises Development (MSMED) Act 2006, the definition of micro, small and medium enterprises engaged in manufacturing or production and providing or rendering of services is being modified."
— RBI Circular, 4 April 2007 (Credit flow to Micro, Small and Medium Enterprises)
Why did the old investment-only definition fail? Because businesses gamed it. A factory owner who could afford modern equipment worth Rs 2 crore would deliberately purchase outdated machinery for Rs 90 lakh to stay within the SSI limit and retain the subsidized credit that came with it. The investment cap punished efficiency and rewarded stagnation.
Why did the 2020 definition revision matter so much?
The game-changing reform came in June 2020 when the Government revised the MSME classification through a gazette notification, moving to a composite criterion of both investment and turnover. Under the revised framework — now further updated by Gazette Notification S.O. 1364(E) dated 21 March 2025 — the thresholds are:
- Micro enterprise: investment up to Rs 2.5 crore, turnover up to Rs 10 crore
- Small enterprise: investment up to Rs 25 crore, turnover up to Rs 100 crore
- Medium enterprise: investment up to Rs 125 crore, turnover up to Rs 500 crore
The old memorandum-based registration system was replaced by the Udyam Registration portal — a single online form linked to Aadhaar and PAN, auto-verifying data from the GST and income tax systems. The Master Direction on Lending to MSMEs (FIDD.MSME & NFS.12/06.02.31/2017-18) requires that for priority sector classification purposes, banks rely on the classification recorded in the Udyam Registration Certificate.
Why does this matter? Because adding turnover as a criterion closed the gaming loophole. A business can suppress its investment figure by buying cheap equipment, but it cannot easily suppress its turnover without also suppressing its GST filings — which would create tax liability problems. The dual test made the classification harder to manipulate.
Where does the 7.5% micro-enterprise sub-target come from?
The PSL Master Directions of September 2020 RBI/2016-17/81 (since withdrawn) — now superseded by the 2025 PSL Directions (Master Directions - Reserve Bank of India (Priorit) — established a specific sub-target: 7.5% of ANBC or Credit Equivalent of Off-Balance Sheet Exposures (CEOBSE), whichever is higher, must flow to micro enterprises.
"Micro Enterprises — 7.5 per cent of ANBC or CEOBE, whichever is higher"
— Master Directions on Priority Sector Lending, 2020 RBI/2016-17/81 (since withdrawn)
This target applies to domestic commercial banks, regional rural banks, and small finance banks alike. The overall PSL target remains 40% of ANBC for commercial banks and 75% for small finance banks and RRBs, but the micro-enterprise sub-target is carved out separately within that envelope.
Why the carve-out? Because without it, banks were meeting their MSME obligations by lending to medium enterprises — companies with turnover in the hundreds of crores that had audited financials, collateral, and established banking relationships. A medium enterprise looks like a regular commercial borrower with an MSME label. A micro enterprise — a street-level workshop, a two-person repair shop, a home-based food business — requires fundamentally different underwriting. The sub-target forced banks to build lending products for the bottom of the pyramid rather than skimming from the top.
The MSME Lending Master Direction goes further, mandating that banks achieve 20% year-on-year growth in credit to micro and small enterprises, 10% annual growth in the number of micro enterprise accounts, and channel 60% of their total MSE lending to micro enterprises specifically.
How does CGTMSE solve the collateral problem?
The Credit Guarantee Fund Trust for Micro and Small Enterprises (CGTMSE), operated jointly by the Government of India and SIDBI, addresses the fundamental obstacle that prevents micro enterprises from borrowing: they have no collateral. A roadside machine shop cannot pledge real estate. A home-based textile unit does not own the building it operates from.
Under CGTMSE, banks can extend collateral-free credit to micro and small enterprises, with the trust guaranteeing the loan against default. The MSME Lending Master Direction mandates that banks not accept collateral for loans up to Rs 20 lakh to MSE units, and permits banks to increase this collateral-free limit to Rs 25 lakh based on the borrower's track record.
"Banks are mandated not to accept collateral security in the case of loans up to ₹20 lakh extended to units in the MSE sector."
— Master Direction on Lending to MSMEs, Chapter IV
Why is this mandate necessary rather than optional? Because without it, branch managers default to asking for collateral — it is the easiest credit decision framework. The mandate strips away that option for small loans and forces the bank to underwrite the business itself rather than the assets behind it. The CGTMSE guarantee makes this commercially viable for the bank: if the borrower defaults, the trust covers the loss.
The U.K. Sinha Committee report, released on 18 June 2019, recommended significantly expanding CGTMSE coverage and simplifying the claim process — recognizing that even with the guarantee in place, banks were reluctant to lend because the claim settlement process was cumbersome.
What problem does TReDS actually solve?
The Trade Receivables Discounting System is an electronic platform where MSMEs can convert their unpaid invoices into immediate cash. The problem it addresses is straightforward: a micro enterprise supplies goods to a large corporate buyer, issues an invoice for Rs 10 lakh, and then waits 90 to 120 days for payment. For a business operating on thin margins with no cash reserves, that wait can be fatal.
On TReDS, the MSME uploads the invoice, the corporate buyer accepts it, and financiers (banks and NBFC-Factors) bid to discount it. The MSME receives immediate payment at a small discount; the financier collects the full amount from the buyer on the due date. The transaction happens "without recourse" — if the buyer defaults, the MSME is not liable.
The RBI's circular of 7 June 2023 RBI/2023-24/37 expanded TReDS significantly, adding insurance as a fourth participant to hedge financier risk on low-rated buyers, expanding the pool of eligible financiers under the Factoring Regulation Act, enabling a secondary market for factoring units, and requiring settlement of even unfunded invoices through the platform.
"On an average, 17% of FUs uploaded on TReDS platforms are not discounted / financed; for such FUs, TReDS guidelines require buyers to pay MSME sellers outside the system."
— RBI Circular on Expanding the Scope of TReDS, June 2023
Why did 17% of invoices go unfunded? Because financiers would only bid on receivables from high-rated buyers. The 2023 reforms addressed this by allowing insurance companies to guarantee the transaction — converting the buyer's credit risk into an insurable risk, which dramatically expanded the set of invoices that financiers would touch.
What happened to MSME credit during COVID?
When the nationwide lockdown began in March 2020, MSMEs faced an existential crisis. Revenue dropped to zero overnight, but rent, wages, and loan EMIs continued. The Government responded with the Emergency Credit Line Guarantee Scheme (ECLGS) — a Rs 3 lakh crore package announced in May 2020 under which banks could extend additional credit of up to 20% of outstanding loans to MSME borrowers, fully guaranteed by the National Credit Guarantee Trustee Company (NCGTC).
The RBI's circular of 21 June 2020 RBI/2019-20/255 (since withdrawn) assigned zero percent risk weight to credit extended under ECLGS — meaning banks did not need to set aside any capital against these loans. This was a direct incentive: the Government bore the guarantee risk, and the RBI eliminated the capital cost, making it almost costless for banks to lend under the scheme. [Withdrawn] — this circular has since been withdrawn as the emergency scheme concluded.
Separately, the RBI had already permitted one-time restructuring of MSME advances RBI/2018-19/100 (since withdrawn), allowing banks to restructure stressed MSME accounts classified as "standard" without downgrading their asset classification, provided the aggregate exposure did not exceed Rs 250 million. [Withdrawn] — this too has been superseded, first by the broader COVID-19 Resolution Framework of August 2020 and then by the return to normal asset classification norms.
The Governor's Statement of August 2020 (PR_50174) and the Statement on Developmental and Regulatory Policies of October 2020 (PR_50480) both emphasized continued support for MSME credit flow, extending restructuring windows and expanding the coverage of emergency guarantees.
How does the amendment chain fit together?
The regulatory architecture for MSME lending has been built through two parallel amendment chains that practitioners must track simultaneously.
The PSL target chain: The original PSL framework (pre-2015 master circulars) set overall targets but had no micro-enterprise sub-target. The PSL Master Directions of September 2020 introduced the 7.5% micro-enterprise carve-out, updated repeatedly through 2024, and then superseded by the PSL Directions of 2025 which maintained the 7.5% target while updating the CEOBSE computation methodology.
The MSME lending chain: The Master Direction on Lending to MSMEs (July 2017) consolidated decades of circulars into a single framework, updated most recently in February 2026 to incorporate the revised MSME definitions from the March 2025 gazette notification. This direction sets the operational rules — collateral limits, composite loan caps, the Udyam Registration requirement — while the PSL directions set the quantitative targets.
Between these two master directions and the periodic circulars on restructuring, TReDS expansion, and emergency credit, a bank compliance officer must track at least a dozen active instruments to ensure the branch is meeting its micro-enterprise obligations.
Why does every branch carry this target?
The answer is structural. India has roughly 63 million MSMEs, of which the overwhelming majority are micro enterprises — sole proprietorships and partnerships with fewer than ten employees, operating in rented premises, with no audited financial statements and no collateral. These businesses employ more people than the entire organized corporate sector combined, yet they have historically received a fraction of bank credit.
The 7.5% sub-target exists because voluntary lending to this segment does not work. Without a regulatory mandate, bank credit gravitates toward borrowers who are easy to underwrite — those with collateral, audited books, and established track records. The micro-enterprise target, the collateral-free lending mandate, the CGTMSE guarantee, and TReDS collectively form a system designed to overcome the market failure that would otherwise leave the smallest businesses entirely outside the formal credit system.
The question is whether the targets are being met. As of March 2025, aggregate bank credit to the MSME sector has grown, but the distribution within the sector — between micro, small, and medium — remains uneven. The regulatory infrastructure is in place. The implementation remains a work in progress.
For more on the PSL framework that houses the MSME target, see Priority Sector Lending — The Complete Timeline. For the mechanics of how banks handle shortfalls against these targets, see PSL Targets, Shortfall Penalties, and PSLCs. For the full MSME definitions and lending chain, see MSME Lending: Definitions, Targets, and Credit Flow.
Last updated: April 2026