AI and digital mandates transform MSME lending in India

Traditional banks have long struggled to serve MSMEs effectively due to their reliance on outdated technology and cumbersome credit application processes that clash with the dynamic needs of small businesses. As Mayank Sharma of IIFL Finance highlights, co-lending partnerships between banks and NBFCs, supported by AI-driven underwriting and digital infrastructure, are bridging this gap by combining banks' low-cost capital with NBFCs' local market expertise, thereby enhancing credit access and reducing MSMEs' dependence on informal finance.

Embedding credit access directly into trusted payment platforms revolutionizes MSME lending by leveraging real-time payment and cash flow data to craft personalized, transparent credit proposals. This integration, as seen in platforms combining accounts, cards, and payment terminals, builds trust and streamlines lending by aligning offers with the actual financial rhythms of MSMEs, effectively transforming lending from a separate, burdensome process into a seamless part of everyday business operations.

AI-driven underwriting is reshaping MSME lending by analyzing real-time transaction behaviors, supplier-buyer relationships, and cash flow patterns to enable dynamic, contextual financing embedded within digital marketplaces. This shift, underscored by the Reserve Bank of India's co-lending framework and India's robust digital infrastructure including Jan Dhan, Aadhaar, and UPI, allows lending decisions to be proactive and personalized, moving away from static historical financials towards a responsive, marketplace-centric model.

The future of MSME lending hinges on responsible AI that balances extending credit access with rigorous risk management through explainability, governance, and human oversight. As emphasized in recent interviews, success will favor institutions that evolve from closed systems to open, API-first ecosystems collaborating with fintechs and marketplaces, embedding credit invisibly into business workflows while maintaining trust and regulatory compliance—a critical evolution given the decline in first-time MSME borrowers from 52% to 42% over three years.

By mid-2026, the Indian government mandated that all Central Public Sector Enterprises (CPSEs) settle ₹3.47 lakh crore worth of MSME invoices exclusively through RBI-authorised Trade Receivables Discounting System (TReDS) platforms, a move that has dramatically accelerated the adoption of digital invoice financing. This policy not only enables MSMEs to convert approved invoices into immediate working capital through competitive discounting by banks and NBFCs without collateral but also addresses chronic payment delays that have long plagued the sector. The explosive growth of TReDS invoice discounting—from ₹40,000 crore in FY22 to ₹3.47 lakh crore in FY26—underscores the transformative impact of embedding digital trade finance infrastructure within public procurement.

The mandate also enforces rigorous transparency and payment discipline by requiring CPSEs to disclose MSME invoice details routed through TReDS and obtain statutory auditor certification during annual audits. This dual compliance mechanism strengthens governance and accountability, ensuring that invoice financing is not only accessible but also monitored effectively. As a result, the policy enhances payment accountability and mitigates risks associated with delayed or opaque payments, fostering a more reliable financial ecosystem for MSMEs.

While currently focused on CPSEs, this policy is widely viewed as a catalyst for broader adoption of digital invoice financing across private sector supply chains, potentially revolutionizing MSME liquidity management nationwide. The India SME Forum highlights that digital procurement platforms, bolstered by GST-compliant invoicing and flexible credit facilities, are shifting from cost centers to strategic growth drivers. Vinod Kumar, president of the Forum, emphasizes that reducing procurement costs via digital tools is gaining prominence, while Amazon Business’s Mitranjan Bhaduri notes that digital procurement expands MSMEs’ market access through verified suppliers and transparent pricing, further enhancing working capital efficiency.

Despite digital advances, the dominance of manual invoice processing among MSMEs creates a critical bottleneck, limiting the reach of AI-driven financing and slowing ecosystem-wide transformation.

Co-lending partnerships between banks and NBFCs, supported by the RBI’s regulatory framework, are strategically transforming MSME credit access by combining low-cost capital with local market expertise and leveraging India’s robust digital infrastructure such as Jan Dhan, Aadhaar, UPI, and the Account Aggregator framework. Mayank Sharma of IIFL Finance highlights how AI-led underwriting and digital onboarding enhance the efficiency and impact of these models, enabling last-mile credit delivery that reduces MSMEs’ dependence on informal finance and addresses longstanding credit gaps.

MSMEs continue to grapple with persistent cash flow challenges driven by structural payment mismatches—paying suppliers within 7 to 14 days but often waiting up to 90 days for customer payments—exacerbated by regulatory shifts like the July 2026 'Payday Super' removal of quarterly payment buffers. This liquidity crunch, coupled with tightened lending criteria from traditional banks, has accelerated MSMEs’ migration toward alternative finance and fintech platforms that utilize real-time transaction data and AI for rapid credit decisions, with capital deployment times shrinking from weeks to mere days, as noted in analyses from mid-2026.

A critical bottleneck in MSME finance lies not in the scarcity of data but in the fragmentation and lack of connectivity among data sources, leading traditional underwriting to over-rely on static collateral and historical financials. Industry leaders stress embedding finance seamlessly into business workflows through programmable payments, tokenized assets, and digital documentation, which automate and accelerate processes like invoice payments and working capital management. This shift toward supply chain finance models that use commercial transactions as dynamic indicators of repayment capacity allows financing to evolve alongside business growth, fostering more responsive and contextual lending decisions.

Despite digital advances, nearly 70% of Indian MSMEs still depend on manual invoice processing, with sectors like manufacturing leading the adoption of AI-driven automation tools to tackle this inefficiency. Concurrently, digital procurement is emerging as a key growth driver by expanding MSMEs’ access to verified suppliers and transparent pricing, as emphasized by Mitranjan Bhaduri, who notes that platforms like Amazon Business integrate GST-compliant invoicing with government systems to ease compliance and accelerate input credit claims. However, with only 30 to 40 percent of procurement spending digitized, and payment delays persisting, legislative measures such as the MSME Development (Amendment) Bill, 2026 mandating invoice settlement via TReDS for central public sector enterprises, are reinforcing the digital infrastructure needed to overcome these entrenched challenges.