Enabling SME financing: The three pronged market-led solutions that can make a difference

Enabling SME financing: The three pronged market-led solutions that can make a difference

Micro, Small and Medium Enterprises (MSMEs) have been one of the strongest drivers of growth, entrepreneurship and employment in the Indian economic growth story. The sector accounts for 30% of the GDP, 48% of the total exports and 95% of the industrial units in the country. In terms of employment, it employs 40% of India’s workforce. To achieve our goal of a $5 trillion economy, the MSME sector requires the right impetus to transition into larger and mature firms. This goal is contingent upon the right infrastructure support and policy to solve the biggest obstacle for MSMEs: enabling market linkage and credit access.

As per an IFC report, SMEs take up a miniscule 6-7% credit share and face a credit gap of close to $1.1 trillion. The gap can be attributed to the systemic challenges like reliance on past credit history and unawareness of the digital lending solutions. The credit scarcity is met by the formal lenders only 40% of the time due to the difficulty in assessing the creditworthiness of the MSMEs due to lack of credit history and preference for collaterals rather than cash flows. It is a vicious cycle as the MSMEs can’t create credit history due to lack of formal lending. The insufficient data is not only making creditworthy MSMEs left out but also making it expensive for them. With banks serving the larger corporates and microfinance catering to the bottom of the pyramid production needs, the MSMEs in the middle have largely been starved for access to robust capital sources.

Targeted government policy interventions like Automatic FDI route, Credit Guarantee Trust Fund for Micro & Small Enterprises (CGTMSE), Credit Linked Capital Subsidy for Technology Upgradation (CLCSS), Micro & Small Enterprises Cluster Development (MSE-CDP), Scheme of Fund for Regeneration of Traditional Industries (SFURTI), Scheme for Promotion of Innovation and Rural Industries and Entrepreneurship (ASPIRE) have bridged the gap, albeit marginally.

The age of data and technology-led SME platforms

The larger part of the credit gap will have to be solved through structural, market-led solutions. Emerging startups are largely enabling credit on three fronts: digital/phygital distribution engine, creating alternate data sets for underwriting and lending/co-lending along with traditional lenders to MSMEs (NTC/Thin Credit & Banking). These fintechs are using tech to remove the inefficiencies in the market making access to credit faster, economical and contextual for the MSMEs. Multiple approaches include online lending platforms/credit underwriting platforms, supply chain financing platform (SCF), embedded finance solutions and revenue-based financing platforms.

Online lending platforms have been there for a while now and have undoubtedly created a huge impact on the MSMEs – Lendingkart, Indifi, Neogrowth, SMECorner etc, that started their journey as online lending platforms and evolved into co-lending or full-fledged NBFC models. Most of these platforms leveraged alternate data & AI to underwrite and lend to the MSMEs.

Another interesting approach to MSME lending is leveraging the anchor ecosystem (large enterprises/brands), that’s where supply chain platforms have a play – companies like Vayana Network, Credable, Canopi, etc. bring the ecosystem of large corporates, vendors and lenders onto a single platform. Usually, these platforms come with multiple integrations (ERP/Accounting/GST) and have deeper access to the data which is usually not available to banks on real time or otherwise.

When it comes to data, digital ledger and cloud-based accounting software startups such as Khatabook, OkCredit, Hostbooks, etc. are not only providing relevant and affordable accounting/compliance solutions but also sitting on rich structured and unstructured data (transaction, invoice and GST data) that will open plethora of opportunities to enable credit, especially for micro enterprises. Government’s push for digitization of the MSMEs and need for compliance is helping the cause and adoption of such solutions.

Another interesting phenomenon that is revolutionizing MSME financing is embedded finance (EF) that is integrating financial services in non-finance ecosystems (NFE). EF startups, like UPI, are creating standardized unified credit interface (UCI) on top of transactional/super platforms/brands. Also, they reduce the time to market, overall TCO, allow NFEs to create customized products specific to their user cohorts; and all this on opex model, i.e., without deploying engineering teams, portfolio testing, workflows, analytics etc. EF startups come with a set of plug & play integrations that upgrade legacy systems of traditional lenders and hence their ability to distribute their products on new age ecosystems. Embedded finance is potentially a $7 trillion market.

Within embedded finance that is catching up like wildfire is the Buy Now Pay Later (BNPL) model which allows the MSMEs to purchase on credit that otherwise find it difficult to get financing. BNPL can become the fastest growing payment option for B2B E-commerce setups like Flipkart wholesale, Walmart, Tata Business Hub, Metro etc. BNPLs are expected to account for more than 50% of embedded finance revenue by 2026.

Another avenue of credit is via revenue-based financing platforms; this works for D2C brands & SaaS companies with lesser burn and/or predictable revenue cash flows, but looking for seamless experience of credit on tap. Startups like Recur, Velocity, Getvantage, etc. have taken a shot at this by creating a platform for this and focusing on creating seamless credit experience for the MSMEs.

We believe that embedded finance infrastructure and solutions with deeper integration within the MSME ecosystem are going to create the next big wave in the SME lending space. Thus, creating a paradigm shift in the MSME lending space from rigid, asset-based financing to cash-flow/transaction-based customized/contextualized financing solutions.

The writer is Managing Director, Merisis Advisors. Anuj Mehta (Director) and Jinsey Jose (Associate) at Merisis Advisors contributed to this article.

(The one-stop destination for MSME, ET RISE provides news, views and analysis around GST, Exports, Funding, Policy and small business management.)

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