MSME Financing and Roadmap for 2021

Guest Article by: Mr. Shachindra Nath, EC & MD, U GRO Capital

MSMEs are the backbone of the Indian economy, playing a pivotal role in employment generation and equitable development. But the sector has been unable to unlock its true potential due to a lack of access to timely, low-cost, formal credit. Without adequate financing, small businesses can’t invest in technology, upskill workforces, and improve infrastructure.

MSMEs are also one of the worst-hit sectors in the COVID-19 pandemic due to severe liquidity crunch and low demand caused by subsequent lockdowns, and a global economic slowdown.

As we prepare to enter the New Year, it’s time to form a roadmap of recovery and growth for this dynamic sector, critical to achieving India’s vision of economic self-reliance.

Financing Instruments and Ecosystem

Traditional lenders like banks and NBFCs are becoming increasingly risk-averse, adversely impacting credit disbursal to cash-starved businesses. In the absence of sufficient credit history and relevant records, banks require adequate collaterals, which small businesses may not possess. Result? High-cost loans or decline in credit flow.

Cash flow based lending, an alternative to asset-based credit, can help reduce the credit gap, as in this model, instead of business assets, lenders consider projected future cash flows of borrowers. With innovative lending models and the right fintech partners, banks can offer cash flow based lending, which will serve the dual purpose of extending credit to MSMEs while reducing the risk of NPAs.

Policy reforms and lending infrastructure innovations are essential for creating an ecosystem that promotes ease of doing business and hassle-free access to capital. Take the Open Credit Enablement Network or OCEN protocol, for example. Introduced to ‘democratize credit,’ OCEN is a set of APIs that will connect lenders and marketplaces and help them offer innovative, low-cost credit digitally to MSMEs. OCEN is a credit rail that will establish a common protocol for lenders and help standardize the loan application process, making them faster and seamless. OCEN aims to digitize India’s credit infrastructure and help lenders offer small-ticket loans.

Another groundbreaking initiative reshaping the credit ecosystem is GeM Sahay, one of the pilot projects of OCEN. It is a government e-marketplace platform that allows LSP (Loan Service Providers) to offer affordable credit to small businesses.

Digital Transformation of MSMEs

COVID-19 has shown the need for digital transformation for business continuity. As customers demand more seamless, contact-free, and secure services, small businesses need to embrace technology and rethink their business models. During the lockdown, many offline stores have launched their websites or apps or set up shops on online marketplace services to offer end-to-end online shopping experiences with digital payment facilities.

Digitization is key to MSME recovery, resilience, and competitiveness in the post-pandemic era. A robust digital presence helps MSMEs expand their presence across geographies and offer maximum convenience and hassle-free customer service. By establishing an online presence, MSMEs also create a digital footprint, essential for accessing formal credit.

By integrating technology into various business functions, MSMEs can automate and streamline processes and increase their operational efficiency. Adopting cloud services, CRM, accounting, and ERP systems, can help them deliver enhanced services faster and at a lower cost. In the future, a centralized effort is needed to improve MSME digital literacy, increase their technological know-how, upskill workforces and catalyze new-age technology adoption such as AI, big data analytics, IoT solutions, and more.

Role of Banks and NBFCs

With the introduction of the new Co-Lending Model (CLM), banks can now co-lend with registered NBFCs and HFCs to provide credit to unbanked and underbanked MSMEs. This is a potential win-win for all parties: banks can cater to wider markets without huge operational expenses by capitalizing on the larger reach, scale, operational abilities and technological capabilities of NBFCs who ensure better last-mile connectivity. On the other hand, NBFCs, facing a liquidity crunch, can benefit from adequate liquidity and financial backing from banks.

Technology adoption by lenders can make the credit disbursal processes faster, secure, and convenient while reducing their risk exposure. Lenders can reduce the need for face-to-face interactions by building digital interfaces that lower operational expenses and serve MSMEs even in the remote locations.

Digital lenders can deploy technology to authenticate borrowers and assess their creditworthiness, using data from alternative sources, such as online behavior. This reduces their reliance on formal data documents and is a boon for thin-file MSMEs.

Digital lenders can also harness the power of game-changing technologies such as AI, ML, Big Data analytics to form a more comprehensive borrower risk profile and detect and mitigate the risk of frauds and loan defaults. An improved risk management framework means faster and more insight-driven decision-making when it comes to loan underwriting.

Timely access to adequate capital can take Indian MSMEs to new heights of success, both nationally and globally, and truly champion the cause of financial inclusion.