By Anuj Pandey
The MSME sector, comprising approximately 30% of India’s GDP, is a formidable economic force, boasting over 35% share in manufacturing output and contributing roughly 40-45% to exports. Its pivotal role in shaping India’s economic landscape is undeniable. Recognizing its potential, government initiatives such as ‘Atmanirbhar Bharat’ and ‘Make in India’ aim to strengthen and enhance the MSME sector.
This commitment is evident in the increased registrations on platforms like the UDYAM portal, which now boasts a total of 2.28 crore registrations, including an additional 80 lakh MSMEs as of Jan 2024, employing 453 lakh people. The sector also plays crucial roles in export revenue, innovation, and social development. With India aspiring to become the world’s third-largest economy, with a GDP of $5 trillion in the near term and $7 trillion by 2030, the burgeoning MSME sector holds immense promise for India’s economic growth.
As we stand at the crossroads of economic evolution, the success of MSMEs is closely tied to their access to timely and adequate credit. Credit facilitation emerges as a critical driver for the sustained growth of these enterprises, as their ability to thrive often hinges on their access to financing. If anything, we’ve just about scratched the surface as India’s MSME credit segment. Supplementing the government’s vision to increase MSME contribution to 50% of the country’s GDP, presents a significant lending opportunity and untapped potential for lenders to innovate and adopt a focused approach.
The lending landscape in India’s MSME sector has undergone rapid transformation since the Covid-19 pandemic. There has been a significant evolution in the MSME lending ecosystem, from moratoriums and emergency credit assistance schemes to on-tap credit utilizing modern credit decisioning tools.
Leading this transformation are fintechs and NBFCs (Non-Banking Financial Companies), leveraging their extensive reach and technological prowess to introduce innovative lending solutions, thereby playing a crucial role in reshaping the lending landscape. If we look at the credit bureau data, it suggests that after the pandemic, delinquency rates have fallen more steeply for medium-sized enterprises, followed by small and micro enterprises. Lender-wise it has fallen more sharply for PSBs, followed by NBFCs and private banks.
A resilient credit facilitation ecosystem necessitates collaborative efforts among governments, financial institutions, and MSMEs themselves. To fully unlock the potential of MSMEs, concerted actions are required to establish and sustain a robust credit network tailored to the sector’s needs.
Sharply defined target segment
Within the diverse MSME sector, encompassing industries like food processing, light engineering, electrical equipment, and retail, each business category faces unique challenges and liquidity cycles. For example, auto component manufacturers may experience peak demand from September to March, while hospitality entities see increased demand during the summer months. A sharply defined target segment for MSME lending involves categorizing businesses based on size, industry, creditworthiness, and financial needs. This allows lenders to tailor lending products and outreach strategies to meet specific needs, enhancing efficiency, risk management, and profitability.
Data-driven underwriting
We are observing a transition towards digital data-driven underwriting, which incorporates non-traditional data sources such as GST filings, utility payments, and order book sizes to evaluate creditworthiness. Data analytics is pivotal in risk management, assisting in the selection of customers by analyzing their financial transactions and repayment histories.
By regularly refining strategies based on data insights, lenders can make well-informed decisions. Automation, bolstered by data strategies, streamlines application evaluations, reduces errors and facilitates personalized risk-based pricing. Moreover, data aids in identifying and addressing biases in AI algorithms, ensuring equitable lending practices and maintaining portfolio quality.
This approach holds particular relevance in countries like ours, with a strong yet largely underserved and unorganized MSME sector. However, it presents cultural and operational challenges, necessitating significant investment in training and upskilling frontline teams and data scientists to develop innovative machine learning-based solutions utilizing non-financial data.
Leveraging the ecosystem through partnerships
Collaboration more than competition will help the lending ecosystem flourish. NBFC lenders can make a large-scale impact only if they individually leverage their strengths while complementing other players. Co-lending is one such illustrative example with the potential to completely change the business models of NBFCs in a scalable and sustainable manner. Since the RBI revamped the co-lending model in 2020, it has grown by leaps and bounds. NBFCs and fintechs across the spectrum are now collaborating with banks to offer loans to deserving small businesses.
Regulatory compliance and data protection
Adhering to regulatory requirements is vital for businesses to operate legally, avoiding penalties and reputational harm. In today’s lending landscape, it stands as a crucial pillar. Likewise, safeguarding data is imperative in an era of prevalent cyber threats. Robust security measures are necessary to prevent unauthorized access and misuse of sensitive information.
Prioritizing regulatory compliance and data protection demonstrates ethical commitment, fostering trust and accountability. It also cultivates a secure business environment, boosting customer confidence and mitigating risks associated with non-compliance and data breaches. With evolving regulations, lenders must ensure compliance and bolster data privacy measures to safeguard borrower information, averting disruptive consequences.
India’s MSME sector holds immense potential, which can be unleashed by freeing it from the constraints of credit scarcity. To achieve this, NBFCs must emerge as a significant component of the country’s lending ecosystem. They need to adopt innovative strategies and robust frameworks, leveraging technology and fostering collaborations to meet the diverse needs of MSMEs and foster sustainable growth. Prioritizing customer-centric approaches and regulatory compliance is crucial to establish trust and credibility. With a proactive approach and commitment to excellence, NBFCs are poised to make a substantial contribution to the resilience and prosperity of India’s dynamic MSME ecosystem.
Anuj Pandey is the Chief Risk Officer at U Gro Capital Ltd. Views expressed are the author’s own.