Credit and Finance for MSMEs: The credit gap in the MSME sector is massive, roughly Rs 20-25 lakh crore, according to a June 2019 report by the UK Sinha Committee constituted by the Reserve Bank of India (RBI). That’s equivalent to at least Pakistan’s gross domestic product (GDP) of Rs 20.08 lakh ($262.61 billion) in 2020, as per data from the World Bank. The reason for the enormous credit gap is two-fold: One, lack of assets among MSMEs such as land and building etc., to secure asset-based financing or secured loans, and two, challenges faced by financial institutions in credit risk assessment owing to lack of financial data and credit history among small businesses.
As a result, lenders over the past few years have started to acknowledge the cash flow-based approach to disburse credit to MSMEs through alternative data sources such as UPI transactions, income tax returns, GST returns, bank statements, CIBIL score, point-of-sale data, and more. The loan amount generally ranges from Rs 20,000 or less to Rs 2-3 crore.
Cash flow-based loans are generally working capital loans required for short-term to manage operational expenses in a business such as rent, salaries, administrative expenses, business travel, raw material purchase, and more. Buy Now Pay Later, invoice-based financing, supply chain financing, co-lending, etc., are some of the collateral-free credit options for small borrowers depending upon their requirements and based on the cash flow data of their businesses.
The growing focus among lenders on cash flow-based credit has come in the backdrop of the RBI’s suggestion towards adopting cash-flow-based lending instead of balance sheet-based. “To improve the credit to gross domestic product (GDP) ratio, access to credit and cost of credit need to be addressed by lesser reliance on collateral security and greater cash-flow based lending,” the RBI governor Shaktikanta Das had said at a webinar on investor education organised by National Council of Applied Economic Research (NCAER) in December 2020.
However, cash flow lending’s share in the overall lending that both banks and NBFCs do together is currently very minuscule as it 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,” Ajay Srinivasan, Director, Crisil Research had said at the SME Artha event organised by Financial Express in November last year. This commensurately means that operating expenses (OpEx), at least initially as the firm gets established, remain on the higher side, Srinivasan had said.