Digital payment tools like portable card readers empower MSMEs such as food truck vendors, making financial services more accessible than ever.

Serving MSMEs: Why Banks Struggle and How Education Can Help

Micro, Small, and Medium Enterprises (MSMEs) are the backbone of every economy. They make up more than 90% of businesses, provide over 50% of employment, and drive local innovation and growth. So why do banks continue to struggle to serve this vital sector effectively? It is often for good reasons, and understanding why is critical for any retail bank that wants to compete in this fast-growing but still underserved market.

It is no surprise that most banks tend to cater to established businesses, who have the financial data and the other paperwork or data to tick the boxes when it comes to making loan applications. In the last decade, we have seen many new consumer and MSME finance businesses successfully grow by serving the long tail of the market, as innovative technologies have made it easier to serve micro and small businesses. These new lenders often did not start with lending in mind. Think of Square as an example, which turned smartphones into payment terminals. It focused first on art fairs, expanded to food trucks and market stalls, and has grown into a global provider of payments and loans to MSMEs. Digital Credit Providers such as Tala use machine learning and alternative data sources to lend to MSMEs in developing markets, offering speed and convenience that most banks find hard to match.

High Risk and Early Failures

MSMEs face daunting odds: around 70% fail within their first five years. The reasons are well known, and include insufficient capital, poor management skills, lack of market demand, and stiff competition. For banks, these high failure rates translate into heightened credit risk and significant caution when considering lending. Traditional risk models, built for larger corporates with reliable financial records, often exclude MSMEs or demand personal collateral, which many entrepreneurs cannot provide.

Limited Transparency and Informality

Another pain point is the nature of MSMEs themselves. Many operate in the informal sector, without full registration, audited accounts, or reliable reporting. Even among formal businesses, financial statements are often inconsistent or incomplete. For banks, this lack of transparency increases the cost of due diligence and makes credit assessment complex, time-consuming, and costly relative to potential returns.

Regulatory and Capital Requirements

Post-Basel III, banks face stringent capital adequacy rules. These incentivise lending to large, better-rated corporations rather than riskier small businesses. The result? MSMEs are frequently left out, despite their importance to economic development. Banks must balance regulatory compliance with the real needs of smaller clients which is often a losing equation when the costs of compliance outweigh the revenue from small-ticket loans.

High Cost to Serve

Unlike corporates, where larger loans spread costs across bigger margins, MSMEs require high-touch engagement. They need advice on business planning, cash flow management, financial literacy, and even digital adoption, yet these services add to the cost of servicing accounts that generate limited revenue. Relationship managers may lack entrepreneurial experience, meaning they cannot easily relate to or advise small business owners. Without new tools, banks struggle to scale support effectively.

Trust Gap Between Banks and Entrepreneurs

For many MSME owners, banks are viewed as transactional partners rather than partners in a relationship. Passion, resilience, and risk-taking drive entrepreneurship, while banks often appear cautious and rigid. Building trust and long-term relationships requires banks to move beyond products and into partnership, supporting clients across their business life cycle, from launch to growth, maturity, and even restructuring. Many if not most banks have not yet moved to create this partnership approach into their banking cultures.

The Way Forward

To break these barriers, banks need to rethink their approach. Tailored solutions, inclusive credit policies, and innovative use of technology are essential. For instance, artificial Intelligence and machine learning tools can act as a co-pilot, helping banks segment MSMEs better, anticipate cash-flow challenges, and provide proactive advice at scale. Financial literacy and advisory services, too, can reduce failure rates and create more sustainable client relationships.

This is where education matters. Retail Banking Institute’s programmes equip bankers with the skills, tools, and mindset needed to engage MSMEs effectively. By learning to understand entrepreneurs, tailor support to their life cycle, and apply digital solutions for financial inclusion, bankers can transform MSMEs from a risky segment into a growth opportunity.

Serving MSMEs is not just about credit. It is about partnership, resilience, and innovation. With the right training, banks can turn today’s challenges into tomorrow’s competitive advantage.