MSMEs have a new champion: How fintech firms have stepped in to help solve the credit problem

Despite playing a pivotal role in the country’s development, these firms encounter immense challenges in securing the capital required for their expansion. They often struggle to obtain loans from traditional banking institutions, which are known for their lengthy approval processes, high collateral requirements, and stringent criteria. As of April 19, 2024, the MSME sector had received Rs 10.4 lakh crore in credit from banks, compared to the Rs 9.07 lakh crore a year ago (April 21, 2023), a jump of 15%, data from the Reserve Bank of India (RBI) shows.

Even though MSMEs are getting more financial assistance than earlier, formal credit is available to a mere 14% of MSMEs in India. Capital is essential for the growth of any business: Starting from micro-enterprises with an annual turnover below Rs 5 crore, to small with an annual turnover of less than Rs 50 crore, and then medium with an annual turnover of less than Rs 250 crore. But, the problem is complicated since they are spread across sectors. “When we think about MSMEs, most of us like to think about MSMEs in some industrial corridor or view them primarily as manufacturing entities. In reality, most are typical grocery shops,” says Ram Iyer, Founder and CEO of supply-chain financing company Vayana. “Only 30% of MSMEs in the country are involved in manufacturing, while the rest are in trading or other businesses, mostly engaged in buying and selling,” he adds.

The size of an entity matters when it comes to obtaining credit, especially from a traditional bank. Explains Iyer: “Because they (MSMEs) are so small, credit is generally not available to them, unless they have collateral, which means that they need to have land or something else that they can pledge. And because these people will probably not have too much land or anything, the amount of money that’s available to them from credit is very small.”

This is where fintechs step in to fill the gap. They are transforming the financial landscape with data-backed models, leveraging alternative information sources, payment histories, and supply-chain financing. These innovations help offer tailored financing solutions and make capital more accessible to MSMEs, thereby fuelling their growth. The numbers also reflect this. According to data from the RBI, credit provided by non-banking financial companies (NBFCs), including fintechs, to the MSME sector has grown three times faster than that of banks (see chart). To facilitate credit, fintechs are partnering with NBFCs or working as standalone entities with their own lending licences. Let’s take a closer look at the credit revolution in the MSME industry.

The Fintech Revolution

A majority of MSMEs in the country face challenges in managing their fixed and working capital requirements. Traditional banks can be a viable choice, but their processes are quite cumbersome and rigid for the ever-changing MSME industry. “Banks typically offer lower interest rates due to their ability to leverage customer deposits for lending. However, the process is often more stringent, with extensive documentation requirements and longer approval times, which can be a hurdle for MSMEs needing quick access to capital,” says Anuj Pandey, Chief Risk Officer at U GRO Capital, a tech-based lending platform.

Moreover, banks often lack confidence in small businesses. Ironically, these are the businesses that require credit the most in order to grow. Incidentally, financial advisory firm Avendus Capital Private Ltd in its latest report on MSME lending said the sector is facing a credit gap estimated to be around $530 billion. Thanks to digital platforms, it’s now easier for MSMEs to access capital. Their method, nonetheless, is intriguing.

Fintechs like Lendingkart, OPL, and U GRO are using alternative credit sources and advanced analytics to provide credit to MSMEs. Efforts are being made to streamline the loan application process, ensuring that credit solutions are faster and more accessible for traditionally underserved borrowers. They are compiling data from various sources, such as social media and mobile apps, GST data, income tax returns, bank statements and credit scores, to determine the creditworthiness of a borrower. “By using digital technology, alternative credit sources, and advanced analytics, fintech companies help emerging businesses secure funds quickly,” says Jinand Shah, MD & CEO of OPL, a digital lending firm.

Harshvardhan Lunia, Founder & CEO of Lendingkart Group, emphasises the significance of utilising alternative data sources and advanced analytics to assess creditworthiness. Fintechs providing an end-to-end digital customer experience is “game-changing,” he says. “This process is not just fast and easy, but unbiased too,” he adds. Lendingkart, which operates as an RBI-registered NBFC and mainly provides loans to MSMEs, has disbursed more than `19,000 crore since its inception in 2014 to over 14,800 pin codes across the country.

There is another set of MSMEs that operates within the supply chain. Even with the abundance of data, many MSMEs still face significant challenges in accessing low-cost credit. This is where fintechs like Vayana help MSMEs by offering a range of trade credit and trade enablement solutions. Vayana facilitates the connection between corporates and their trade ecosystems, offering them a cost-effective way to access credit for their payables and receivables.

“If I go to the big brand and, through their distribution chain find out where a seller is on the supply chain, I can determine if a seller has been active for the last two to three years and whether one has been regularly paying back. This allows us to see things within the context of the supply chain and accordingly can vouch for them because they have been buying and selling regularly,” explains Iyer, adding that by looking at that history, lenders can reach a comfortable level of trust. “Therefore, the supply chain provides a reliable way to contextualise one’s position,” he adds.

Likewise, in the lending space, payments companies such as Paytm and BharatPe have an advantage, as they have access to detailed credit profiles. Knowledge of a merchant’s transactional patterns and financial behaviour enables these companies to undertake risk assessment and tailor lending products accordingly. “Payments companies have also marked their presence in the lending market due to UPI. Hence, one can track the money inflow and outflow. Now, that’s a very good model,” says Iyer. However, the only issue is that Indian businesses don’t favour one payment service. “For example, if you go to a textile garment shop today, you will find 2-3 PoS machines and multiple UPI QR codes; so data is spread across,” says Iyer.

The Future Course

With initiatives like GSTN, e-invoicing, and schemes like the Mudra Yojana and the Account Aggregator Framework, the country is becoming increasingly data-rich. This holds the potential to revolutionise credit assessment and affordability for MSMEs. “Eligible MSMEs should register with Udyam, as it offers multiple benefits, including collateral-free loans from banks and financial institutions, subsidised interest rates, and simplified processes for obtaining licences, permits, registrations, and approvals,” says Shah.

Agrees Pandey of U GRO. “It not only formalises the MSME but also provides access to numerous government schemes, benefits, and subsidies tailored for MSMEs. These formal registrations help build a robust credit profile, making it easier for NBFCs like us to extend tailored financial solutions swiftly and efficiently,” he says.

MSMEs are increasingly turning to fintechs for their speed and innovative financial solutions. This combination of banks, NBFCs, and fintech firms provides MSMEs with options for managing their capital needs. “Fintech inclusive and data-driven approach has expanded the credit market for MSMEs, enabling them to secure the necessary funding for growth. According to a report by EY, digital lending is expected to reach `47.4 lakh crore by 2026. This is a potential opportunity for MSMEs,” says Manish Lunia, Co-founder of FlexiLoans.com, an MSME-focussed RBI-registered NBFC. MSMEs can, hopefully, look forward to a brighter future. 

@teena_kaushal