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How Various Lenders Fill the Small Business Credit Gap


In recent years, MSMEs have been badly hurt by demonetization and policy reforms such as the GST, which have inflated compliance costs that small entrepreneurs have struggled to bear. The pandemic of the past two years and, more recently, high inflation have only aggravated their financial and operational difficulties.

According to the Ministry of MSMEs, the country has 63.3 million MSMEs. These companies contribute about 30% of the country’s nominal GDP and 48% of its exports. But the vast majority of them do not have adequate access to formal credit. Therefore, small businesses are affected by a lack of cash for working capital as there is a time lag in receiving payments from customers as well as capital expenditure due to lack of adequate documents and collateral. required for traditional forms of lending.

Barriers and risk factors

Although the Center has launched numerous tax initiatives to support MSMEs, including the Emergency Credit Line Guarantee Scheme (ECLGS), less than 10 million small businesses have been eligible to benefit from these loans. Worse still, most small entrepreneurs are not aware of these loans, which prevents them from benefiting from them.

Thus, barely 40% of the segment’s credit needs are covered by formal credit. For this reason, the MSME credit gap in India is pegged at Rs 30 lakh crore, representing a huge opportunity for lenders. In its 2019 report, the RBI-appointed Expert Committee on MSMEs mentioned three reasons for the large credit gap. The first was the high risk for lenders if MSMEs were unable or unwilling to pay. The second was the high cost of serving these small businesses due to lack of adequate information and lack of collateral. The third was the low presence of lenders in semi-urban and rural areas.

Given the role of micro and small enterprises in national economic growth, the new era digital lender collaboration model can benefit the national mission of inclusive development. Digital loans can help bridge the credit gap and bring micro and small businesses into formal credit. Moreover, a specialized understanding of digital lenders with last mile connectivity ensures negligible cost of credit and hence adequate returns for all stakeholders.

Co-loan model

In such a scenario, the co-lending model (CLM) could benefit small businesses through a symbiotic relationship between digital NBFCs and banks to meet the credit needs of unserved or underserved MSMEs. The CLM allows traditional banks and registered NBFCs to join together to provide loans underwritten jointly by the two entities and disbursed at a ratio of 20:80, with the largest share being provided by the banks.

CLM is a winning proposition for all stakeholders. As fintech companies and digital NBFCs provide last-mile connectivity, helping banks grow without the heavy expense of physical offices, banks have strong balance sheets to offer funds at a cost that makes lending more affordable. FinTech’s digital capabilities and superior understanding of underwriting and collection for these segments improves operational efficiency while reducing the cost of acquiring small customers, enabling funds to be provided at lower rates. lower interest.

Based on their digital lending model, fintech firms offer last-mile connectivity to MSMEs while personalizing credit assessment. With constantly evolving algorithms, in-depth understanding of each niche segment, data from various sources is aggregated through analysis through AI (artificial intelligence), ML (machine learning) and other tools. Backed by AI-based technology, fintechs can provide risk-based interest rates.

Tailor-made offers

In addition, digital NBFCs enjoy the benefits of omnichannel presence (online and offline) as well as fast processing through their fully digital and automated systems. This ensures easy access to loan services and faster processing time. For example, borrowers can apply for loans through a mobile app sitting in the safe comfort of their home or office and have it approved within hours to days. Post-disbursement issues and queries can also be resolved quickly through digital means.

Nevertheless, fintech companies may not have the large balance sheets needed to serve millions of borrowers. On the other hand, banks have strong balance sheets, but conventional standards prevent them from underwriting MSMEs due to inadequate data. Through partnerships between fintech players/new era digital lenders and traditional banks, these constraints can be overcome.

Additionally, as many small and micro businesses struggle to provide adequate collateral, cash flow based lending is being deployed to provide loans through the CLM. With the benefits of partnerships between traditional and new lenders, due diligence is performed by processing both structured and unstructured data for better risk assessment. Thus, micro and small enterprises can receive funds cost-effectively and quickly, kick-starting nation-building activities through greater job creation and inclusive development.



The opinions expressed above are those of the author.