Its quite well understood that MSME’s are drivers of the economy with more than 40% of GDP contribution coming in from MSMEs. Its also well understood that one of the most important challenges or rather impediment faced by MSMEs is the lack of capital availability in form of formal sector loans.
Before we try to understand how online lending start-ups are empowering MSMEs, it is important to understand why does this gap exist. It is but common sense economics, that if there is visible demand and it can be serviced profitably some-one will supply to the segment. The concern therefore, is the belief of the formal lenders, they cannot service it profitably – or at least they think that the segment can’t be serviced profitably.
Let’s get into the head of a traditional banker and why he/ she doesn’t jump at the opportunity present by the vast unmet demand of MSME for loans. (A) I don’t understand the risk – and how do I understand the risk, given the lack of documentation? (B) The MSME owner doesn’t have any (more) collateral to offer either otherwise I could have taken comfort in the value of the collateral (C) I’d rather sanction a INR 1 Cr. loan to a large corporate that chase 10 loans of INR 10 lakh each – my effort in each loan is the same. These are the three main concerns that you’ll hear from any banker who is shy of MSME lending.
Interestingly, the online lending start-ups like CoinTribe are trying to turn each of these concerns into pockets (rather wells) of opportunity!
The reason why most traditional lenders find it difficult to assess risk of a business is because they are married to using financials to assess a business’s eligibility. Unfortunately, what works for large corporates doesn’t fit the MSMEs. Most MSMEs are either used to under-reporting (hopefully some of this will change with the implementation of GST) or just don’t have the resources to maintain books of accounts like mid and large corporates. Given that their account statements are not in good shape, neither is their eligibility for loans. The online lending start-ups are however, going beyond the obvious and mapping out various behaviours, imputing the business scale and confirming the intent of the borrowers by accessing and more importantly analysing the vast amount of data that is either available in the digital ecosystem that traditional lenders have not been looking into or better analysing the data that traditional lenders had access to, but for various reasons have been unable to extract insights from the data that if glaringly obvious to many of the online lending start-ups. Besides, in most banks, the banking set-up with the number of committees and interferences and the sword of a mistaken experiment doesn’t encourage experimentation and learning.
Where is the need for a collateral then? Well that’s debatable, for most part of it if the business can be well accesses, there should be no need for collateral. However, a perfect assessment is always a mirage. The more information the underwriter has the more confident he/ she feels on the decision he/ she is taking. A collateral, may just help the underwriter take either a leap of faith or even help a borrower reduce interest rate at which the loan is offered. While most online lending start-ups are (rightfully) focusing on unsecured loans, we are likely to see a transition into more rounded portfolios. Given that the collateral is only a comfort and not the primary criteria for computing eligibility, we are likely to see even imperfect collaterals help the borrowers in achieving higher loan amount sanctions and/ or lower rates.
Of course, the cost structure needs to be different for different loan sizes. While you can afford a Relationship Manager (RM) for an INR 1 Cr. loan – and sometimes you need one to retain the account, it is quite cost prohibitive to have a RM engage with the same rigour for an INR 5-10 lakh loan. Lending to MSMEs needs to be more retailed than corporatized. We need score-cards taking decisions and machines learning the patterns and improving decision logic. The better lot of online lending start-ups have put in tremendous focus in bringing in cost efficiencies in the application process through automation – while improving their risk assessment capabilities.
With the concerns of the traditional lenders turned into opportunities, we’ll see a significant change in the supply of lending capital to MSMEs – fuelling MSME growth in the times ahead.