Ecosystem-based lending works on a very simple premise: that small businesses are already linked into larger supply chains and are either buying from or selling to bigger businesses.
According to the World Bank, $230 billion is the current gap between the demand and supply of credit within the Indian MSME sector. To put this number in context, the nominal GDPs in 2018 of two of India’s neighbouring countries, Pakistan and Bangladesh, are estimated at $309.7 billion and $285.81 billion respectively.
While numbers do not lie, these statistics shed light on a particularly alarming truth. MSMEs, which contribute over 40% to the country’s total manufacturing output and exports, are starved for the capital they need to sustain and grow their operations.
Finance denied is growth denied
The major reason behind this credit gap is the challenge that traditional banks and NBFCs face while underwriting MSMEs for working capital loans. Most small and medium businesses do not have a consolidated record of their transactions and tax returns. In the absence of such financial data, determining the applicant’s creditworthiness through conventional assessment methodologies becomes almost impossible.
This puts small businesses in a precarious position. Apart from funds required to purchase inventory to drive their day-to-day operations, they also have to meet recurring expenses such as staff salaries and utility payments. Without seamless access to credit as and when required, sustaining their operations – particularly in fast-moving industries such as F&B – becomes extremely difficult. Since they have limited capital, to begin with, many MSMEs barely manage to survive, let alone thrive.
Is such a situation unavoidable for the MSME sector? No, it isn’t, for financial data is not the only factor that can help in determining borrower creditworthiness. The rise of new-age aggregator platforms, as well as the push towards digitisation, has given rise to several non-traditional data points which can be used to assess an MSME borrower. This is exactly where ecosystem-based lending solutions step into the picture, leveraging a tech-led approach to deliver greater value where traditional methodologies fail.
Ecosystem-based lending works on a very simple premise: that small businesses are already linked into larger supply chains and are either buying from or selling to bigger businesses. The idea is to partner with these more established ecosystem players to unlock greater value and benefits in terms of access to credit and financing.
For instance, an online lending platform to small business partners with food delivery platforms to finance restaurants, QSRs, and food outlets associated with the latter. Through this partnership, the lending platform is able to leverage the business’s transactional data available on the partner platform to assess borrower creditworthiness.
This innovative approach to lending eliminates the conventional underwriting challenges associated with MSMEs. By using supply chain data such as order frequency, delivery accuracy rate, duration of business operations on the platform, transactions, etc., fintech players can accurately underwrite small businesses even with limited or no financial or credit history.
Doing so also increases the growth prospects for the MSME sector by extending access to credit to businesses which would otherwise find their demand for capital unfulfilled. Interest rates are also typically lower than conventional working capital loans, reducing the financial burden on the borrowing MSME. Additionally, the repayment plans are quite flexible and can be linked with the clearance of dues and payouts for services rendered.
Seamless credit flow
Since such lending is designed around the need for transactions within the ecosystem, availing credit facilities also becomes easier from an MSME standpoint. For instance, if they want to purchase certain raw materials from larger ecosystem partners, they can now get credit as part of the transaction itself. Business owners are not required to go out of their way to apply for a working capital loan from a bank or an NBFC. Their demand for credit is met, assessed, and fulfilled at their point of need, on the platforms through which they are already conducting their business.
Availing such financing facilities through their pre-existing industry linkages makes it more seamless and natural for businesses to consume credit. Larger ecosystem players can also drive growth for partner enterprises and maximise their own selling and business opportunities. Furthermore, fintech platforms can use their ecosystem partnerships to market their lending solutions more conveniently, to a much larger target audience.
Every business, large or small, has an ecosystem around its products and services. Using this demand origination and supply chain to fulfil MSME credit requirements can unlock greater value for all stakeholders. Innovative lending solutions aimed at fulfilling the credit demand of the MSME sector will not only be beneficial for their connected ecosystems but the larger business landscape as well.
- Alok Mittal, CEO & Co-founder, Indifi Technologies. Views are the author’s own.