Credit and Finance for MSMEs: Informal credit ends up being much more expensive for MSMEs than formal debt making it difficult for them to address accumulated debt burden.
- By Monish Anand
Credit and Finance for MSMEs: The Micro, Small and Medium Enterprise (MSME) sector in India is key to the growth of India’s economy. Around 75 million MSMEs contribute to about a third of the GDP and 45 per cent of the manufacturing output of the country. These companies also provide employment to more than 110 million Indians. The sector’s sustained growth and health are important to achieve India’s GDP growth targets. The sector is currently seeing a huge credit gap. According to a BizFund report, only 16 per cent of MSMEs in India receive formal credit leaving more than 80 per cent of these companies under-financed or financed through informal sources. Informal credit ends up being much more expensive than formal debt making it difficult for MSMEs to address accumulated debt burden.
A combination of factors is allowing companies in the fintech domain to cater to this credit gap. The first one is the continued effort by the government to digitise MSMEs – through skill development, GST rollout, and a wider availability of Aadhaar based KYC to catalyse growth on all fronts. This has provided opportunities to fintech companies to provide data and technology-based services to MSMEs. The second factor is the availability of alternate data (cashflows, online reputation etc.) over traditional data inputs like financial assets and collateral. The third is the availability of technology to assess data that can help in building credit models that can be tailored to different segments of MSMEs.
With the increasing digital footprint and online transactions even in remote locations, fintech companies have a wider market to access. They are also reaching out to the lower-income and unorganised employees of MSMEs through individual tie-ups with employers. This has increased the potential for meaningful financial inclusion for the ‘next billion’ in India.
Fintech companies can reach out to MSMEs by assessing the extent of digitisation of the company and the type of debt required by the company. Close scrutiny of these two parameters will help fintech players in assessing risk and providing tailored solutions as per the MSMEs’ requirement.
The extent of digitization of the operations will determine the cost of debt and the amount of hand-holding required to build a data model for the company. Digitally advanced MSMEs will be able to avail credit sooner with minimum documentation requirements. The others with lesser digital footprint are in a position to build the data required to access formal credit with relative ease form fintech players. This is an opportunity for building a consulting-based business to tap into the numbers that MSMEs can add to the digital lending market. Data availability has to be built on the basis of consent and security requirements to provide innovative solutions.
Through the analysis of cash flow patterns and type of MSME business, businesses will be able to tailor the type of debt – short-term working-capital vs long-term financing options – to be given. Other fintech products like insurance products and investment products can also be offered based on individual MSME operations. Apart from diversifying the portfolio, this will also help fintech companies in setting up analytics to improve credit risk models and containing fraud.
Fintech companies also offer unsecured small business loans that are very useful to SMEs starting up. Banks usually lend to larger companies and are weary to give small loans to SMEs wanting to start new businesses. Fintech lenders offer flexibility in terms of the size of the loan and in repayment options. They have just started making inroads into MSME digital funding, through innovative, data-based lending models. The World Bank estimates the current credit gap for MSMEs in India to be at $380 billion. With continued digitisation efforts and improved regulatory norms for data security and protection, this credit gap is all set to be addressed by digital lenders. Experts opine that the time is right for MSME lending to make it big in the evolving story of India’s fintech space.
Monish Anand is an Ashoka Fellow and the Founder & CEO at Shubh Loans. Views expressed are the author’s own.