Credit and Finance for MSMEs: Discussions around enhancing cash-flow-based MSME lending have been doing the rounds in the lending ecosystem for the past at least four-five years. The model can shrink the time and hassle around raising instant credit for borrowers even as its share in the overall lending space continues to be minuscule, according to experts speaking on Day 1 of Financial Express Online’s SME Artha event.
“MSMEs need timely working capital. Typical processes take months for credit assessment because all of that is based on balance sheet-based lending. The majority or 70 per cent of the MSMEs would never qualify for balance sheet lending. However, they work with some of the largest corporates in the country, have a significant track record of performance, and have healthy cash flows. I don’t think why this data cannot be leveraged to provide them with innovative working capital products. This would provide MSMEs with instant access to working capital, within 24 hours. That’s the problem we are trying to solve at CredAble,” said Nirav Choksi, Co-founder and CEO, CredAble.
The Reserve Bank of India (RBI) had also urged lenders towards adopting cash-flow-based lending instead of balance sheet-based. In December last year, Governor Shaktikanta Das at a webinar had said that “to improve the credit to gross domestic product ratio, access to credit and cost of credit need to be addressed by lesser reliance on collateral security and greater cash-flow based lending.” In 2019 as well, the UK Sinha committee report on MSMEs had said that the introduction of cash-flow lending is essential to ease the credit gap faced by MSMEs.
However, “there are structural barriers for cash-flow lending to MSMEs. Customer Acquisition Costs (CAC) for lenders are high since qualified lenders and borrowers are not connected to each other. Loan Operating Costs (LOC) for processing the loan application, disbursement and chasing repayments are also very high. Some of these costs are fixed and hence, smaller business loans, particularly those under Rs 10 lakhs are considerably less profitable than large business loans and are therefore less appealing to banks,” the report had said.
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Nonetheless, according to the report, unlike other forms of lending (project finance, credit lines, MFI microcredit), cash-flow lending is possible only in a digital lending and payments value chain. For instance, cash-flow lending, at the very minimum, needs visibility to past and future cash-flows. “Beyond visibility, this form of lending benefits from automated controls on cash-flows. For instance, the lender can be assured repayment through a lien on future cash flows. This is now possible due to a set of interlocking Digital Public Infrastructure, as E-Liens.”
The cash-flow model allows banks and other lenders to provide credit to borrowers based on real-time cash flow data such as underwriting, credit product configuration, and repayment. The process doesn’t have to cater to collateral as the basis for lending in the asset-based model. The existing cash-flows allow for providing credit products with the right ticket size of loans with shorter tenure, better turnaround time, and flexibility in repayment periods. However, cash-flow lending’s share in the overall credit market remains small.
“Cash-flow-based lending is a very minuscule part of the overall lending that both banks and NBFCs do together. The reason for lower share is that cash-flow based lending normally requires a lot more discipline on the part of the lender while even closer monitoring of cash flows of the unit is required for lending which commensurately means that operating expenses (OpEx) at least initially as the firm gets established actually being on the higher side. We have started taking baby steps but as part of overall lending, which happens to MSMEs, I would say it is a very minuscule portion,” Ajay Srinivasan, Director, Crisil Research.
Chandrakant Salunkhe who heads SME Chamber of India, however, noted that NBFCs should rework interest rates for affordable financing to MSMEs while the latter too needs to develop an understanding of procedures and compliances involved in the traditional lending model.
“There are nearly 7 crore MSMEs in India and more than 4.5 crore of them are self-employed units depending on traditional funding which is costly. The need of the hour is to properly understand the funding demand of the MSME sector. Also, most MSMEs don’t understand the procedural work, compliances, etc., involved in the process…NBFCs should think about lower interest rate instead of 20 per cent or up to 30 per cent,” Salunkhe said.
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However, the higher rate of interest would continue to remain an issue unless banks enhance their support as the rate of borrowing continues to remain higher at 12 per cent or more for multiple NBFCs. “Banks are sitting on money and investing in AAA-rated NBFCs whereas NBFCs like ours are providing last-mile distribution to micro-enterprises without any liquidity coming to us at any reasonable cost. We gave loans under ECLGS as well without having that ECLGS benefit come to us from banks. The nexus that exists where the bankers are sitting on capital and not releasing to BBB grade NBFCs should be broken,” said Hardika Shah, Founder and CEO, Kinara Capital.
Srinivasan added that while the interest rate is an issue but equally important issue is the timely availability of funds. “While through fintechs, the turnaround time (for credit access) has come down but rate continues to be an issue. Also, the last three years have been very tough as there was IL&FS crisis, Covid problem, etc. So, banks have become extremely risk-averse.”