Information Asymmetry and High Transaction Costs: Challenges for MSMEs In Securing Financial Support

MSMEs are an untapped sector of the Indian economy with the potential to foster growth by benefiting the affluent industry and the country's middle class. There are multiple schemes run by Indian governments to cater to this agenda, but they are still unable to actualize the true potential of the MSME sector. This research paper explores the historical context and contemporary challenges faced by Micro, Small, and Medium Enterprises in India, which struggle to keep pace with other sectors of the economy. Despite their potential to drive economic growth and enhance middle-class livelihoods through increased productivity and employment generation, MSMEs’ potential remained underutilized and constrained by various obstacles. This study uses secondary data from credible sources to investigate key factors contributing to the persistent credit gap between credit demand and supply to MSMEs. The findings reveal that information asymmetry poses a significant barrier to accessing financing, as lenders often lack reliable data on the creditworthiness of potential borrowers. This uncertainty drives financial institutions to favor existing borrowers, leading to a skewed loan disbursement process that favors existing borrowers to reduce the enforcement cost of loan disbursement and collection. It also increases the difficulties for new entrants in getting easy loans from lenders. The paper highlights the urgent need for strong institutions to address these imbalances and capture gains from trade by expanding the credit market to small and new borrowers without any hassle.