How fintechs are empowering MSMEs with increased access to credit

Imagine a small shopkeeper (‘nanopreneurs’) in a remote village running a grocery business. He looks at adding more items to his stock and wants to expand operations but the lack of collateral hinders his ability to get credit from official financial services. 

The absence of a credit history exacerbates the situation, leaving him with limited options and putting a spanner on expansion and growth plans. In another case, imagine an MSME supplying raw materials to a more prominent manufacturer faces delayed payments from the buyer.

As a result, the small firm needs capital to pay its suppliers and meet other financial obligations. It is forced to wind up operations or look for costlier private avenues to raise much-needed funds. These examples illustrate some of the issues MSMEs in India face in the traditional financial system.

MSMEs are often touted as the backbone of the Indian economy, contributing significantly to all avenues of capital generation, including employment, manufacturing and exports. In India, they account for approximately 33% of the GDP and generate over 120 million jobs across various industries. However, this potential growth story faces headwinds in the form of the credit gap that, as described above, hinders its growth potential. 

As of September 30, 2022, the Reserve Bank of India (RBI) reported the credit outstanding to the MSME sector amounted to Rs 20.7 lakh crore. According to the findings of the Expert Committee on MSMEs, led by UK Sinha, the credit gap in the MSME sector was estimated to be around Rs 20-25 lakh crore in 2019.

More than 80% of MSMEs are estimated not to have access to formal financing systems. A paper by Avendus Capital on MSME lending revealed a credit gap of $530 billion in the MSME sector. It suggested only 14% of the 64 million MSMEs in India have access to credit. A report pointed out the credit gap presents a significant opportunity for lenders, with $120 billion belonging to the small-ticket loan segment with a ticket size of less than $1 million.

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Explaining the credit gap

The reasons for this gap are manifold. MSMEs often operate in niche markets with unique business models that traditional lenders cannot understand. They lack extensive financial histories or well-established credit profiles, making it challenging for lenders to assess their risk accurately. Moreover, many small firms will not maintain comprehensive financial records or follow formal accounting practices, and this lack of financial transparency can make it difficult for lenders to evaluate the company's financial health and assess its repayment ability. 

MSMEs, especially those in seasonal industries, are more vulnerable to economic fluctuations and market volatility. It is challenging for lenders to predict their cash flows and assess repayment capacity during downturns or unstable market conditions. MSMEs often struggle to provide sufficient collateral to secure loans, as they lack significant physical assets or have limited access to property or land for collateral purposes. Manually assessing creditworthiness for each MSME borrower can be time-consuming and resource-intensive for banks.

As a result, they might be less inclined to invest in such evaluations for smaller loan amounts, further limiting access to credit for MSMEs. 

Fintech companies have emerged as a game-changer in bridging this credit gap and empowering the MSME sector. The rise of digitalisation, with a leap in internet and smartphone penetration, has paved the way for significant growth in the fintech space. These platforms are leveraging cutting-edge technologies such as artificial intelligence, machine learning (AI/ML) and big data analytics to revolutionise the lending process for MSMEs and correct anomalies.

How do they do it?

Fintech companies have streamlined the tedious lending process with paperless and contactless solutions. With digital documentation and video KYCs, MSMEs can apply for loans online, leading to quicker approval and disbursal times. It enables businesses in remote parts of the country to access reliable credit and empowers them to compete on a level playing field.

Unlike traditional lenders, fintech companies can curate and create tailor-made credit solutions to meet the specific needs of different industries. Whether it's real estate, technology, healthcare, or any other sector, fintech lenders can provide targeted financing opportunities for MSMEs. This flexibility helps bridge the credit gap for businesses with diverse capital requirements.

Moreover, fintech lenders require minimal documentation, making it easier for small businesses with limited credit and operational history to access credit. They employ advanced data analytics to assess a business's creditworthiness comprehensively. By analysing transaction history and other relevant data, fintech companies can predict future cash flow potential, thus facilitating quicker loans for urgent capital needs.

Fintech companies can collaborate with banks through co-lending partnerships to extend credit to MSMEs and help banks reach out to more consumers in remote locations. They can leverage their expertise in alternate credit assessment methods and improved customer experience with their ability to serve the last mile and help offer lending services to underserved MSMEs.

One crucial aspect where the lending platforms excel is their focus on financial inclusion in rural areas. Many MSMEs operate in these regions but have needed help accessing formal credit channels. Fintech companies are working to bring these MSMEs under the credit umbrella by providing accessible and user-friendly online credit application processes. Moreover, agriculture practices that form a vital part of the MSME segment also benefit from fintech solutions. The platforms can design products tailored to the specific credit requirements of farmers, providing funds for essential farming needs such as seeds and equipment.

Fintech companies have emerged as the catalysts of change, leveraging technology to bridge this gap. By providing faster, more accessible, and tailored credit solutions, fintechs can empower MSMEs to drive economic development, create jobs, and foster innovation. With continued innovation and collaboration between fintechs, traditional lenders, and regulatory bodies, the dream of a thriving and inclusive economy for emerging India can become a reality.

(Sanjeev Kumar is Co-founder, Executive Director, and CEO of Spice Money.)