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MSME funding: How FinTechs can help address credit gap for small businesses

A symbiotic relationship between banks and digital NBFCs can lead the way towards a win-win situation for all

Srinath Sridharan | Satyam Kumar | March 3, 2021 | Updated 17:08 IST
MSME funding: How FinTechs can help address credit gap for small businesses
The introduction of the Co-Lending Model (CLM) allows banks and registered NBFCs to co-lend to provide credit

The MSME (Micro, Small and Medium Enterprises) sector is emerging as one of the most significant pillars of the Indian economy as it contributes largely towards nation-building.

"MSME has emerged as the growth engine of the economy with a vast network of about 6.33 crore enterprises contributing 30 per cent of our nominal Gross Domestic Product (GDP) and 48 per cent to exports," said RBI Governor Shaktikanta Das, while addressing an event last week on the occasion of 185th Foundation Day Celebration of Bombay Chamber of Commerce and Industry.

"As digital capabilities improve and connectivity becomes omnipresent, technological innovation and technology-driven revolution are poised to quickly and radically change India's economy", he said. "In the financial sector, this could lead to higher financial inclusion, lesser information asymmetry, and reduced credit risk," Das added.

Across the globe, the MSME sector has been hit hard by the pandemic induced crisis; but even before the crisis, despite proven-growth records, the sector remained not-served-well, due to lack of timely credit access. Credit, for any business, is like the flow of blood, essential for its healthy functioning.

Similarly, credit access helps the economy grow. More importantly, credit access to MSMEs makes for social and financial inclusion and dignity being offered to those entrepreneurs. At present, the MSME credit gap is pegged at around $240 billion (Rs 17 lakh crore).

Also Read: 68% start-ups, MSMEs didn't benefit from Centre's COVID-19 schemes, claims survey

Why FinTechs?

Given the current situation, the pertinent question that arises is: how will FinTechs serve the credit demand of MSMEs in India?

To answer this question, let's look at what banks and digital NBFCs have to offer when it comes to catering to the credit demand of the MSMEs:

Cost of reaching and acquiring a customer  

Digital NBFCs, backed by technology-enabled systems and algorithms, are able to acquire customers at a much lower cost. The speed and agility with which they are able to partner up with online marketplaces, further helps them reduce the costs. Banks, on the other hand, generally have higher costs of acquisition as their branch-led model still largely relies on physical presence and demands higher Opex.

Product customisations

With alternate data acquired via social media and deep technological integrations with digital partners, digital NBFCs are able to provide more product customisations with greater flexibility suited to the borrowers' needs. While the incumbents are not inert and are ramping up their technology, it will take considerable time to move from traditional and legacy ways of underwriting and credit-delivery. But the more difficult transition will be the process flow and associated retraining of their existing staff as well as the culture of fast service that FinTechs are building (without any past baggage).

Also Read: Digital lending: Now more than ever we need fintechs to democratise credit, uplift livelihoods

Ease of Access and processing time

Omni-channel presence and fast processing time are advantages offered by digital NBFCS by using technological tools and systems. A borrower can apply via Whatsapp, Facebook or a mobile application from the comfort of their home and get approval within a few hours of applying. Even post-disbursal customer care is available with the convenience of using a digital medium.

Cost of Capital

Banks and their large balance sheets can serve millions of customers. However, traditional underwriting practices prevent them from underwriting SME segments effectively. FinTechs or Digital NBFCs, on the other hand, have a distinct disadvantage when it comes to the cost of capital as they do not have large cash buffers (unless they use their equity capital to lend, without any leverage). This creates a barrier in their path of providing services at lower rates to the MSMEs. This is also due to the shallow debt markets that our economy has.

Digital lenders may lack large balance sheets or cash reserves but are at the forefront of deploying technology to increase reach at a lower cost of acquisition. And of late, FinTechs globally have been able to raise large sums of equity capital as they build cutting edge credit-decision capability to serve consumers better and faster.

As witnessed in the past, lack of collateral has always raised difficulties for small business owners, and this is where digital lenders found the unique opportunity to serve an under-served segment. Digital lending is powered by technology and thus emerging as a new alternative to traditional lending due to its cost-effective, less time-consuming, and inclusive approaches.

Also Read: SBI will prefer co-origination model to handle financing needs of MSMEs: Chairman

Can Banks & FinTechs collaborate?

Since both banks and digital NBFCs have different strengths, it helps utilise them to serve consumers better and well.

The introduction of the Co-Lending Model (CLM) allows banks and registered NBFCs to co-lend to provide credit. Under a co-lending model, the digital NBFC is entrusted with the task of sourcing loans, which are underwritten jointly by both and disbursed in a 20:80 ratio, with banks holding the larger share. While FinTechs and digital NBFCs help with better last-mile connectivity and can help banks scale up without incurring huge expenses on physical branches, banks and their balance sheets can provide capital at a cost that makes credit affordable.

Thus, rather than being a question of "either-or", a symbiotic relationship between banks and digital NBFCs can lead the way towards a win-win situation for all. And this should have "consumer focus" as its main objective to help drive financial inclusion and better access to credit for MSMEs. In that lies the chance for our speedy economic growth and inclusive social development.

{Srinath Sridharan, independent markets commentator & Member of Governance Council for FACE & Satyam Kumar, CEO - LoanTap Financial Technologies and Co-Founder of FACE (FinTech Association for Consumer Empowerment)}

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