Fostering financial inclusion and bridging credit gap for micro enterprises

India is commended around the world for emerging as a fast-growing economy and now reaching to become a $30 trillion economy, says a government report. With both global and domestic demand rising for India’s products and services, celebrating the economic growth of India would be a miss without the acknowledgement of the micro-small-medium enterprise (MSME) sector in India. 

India is home to the second-largest MSME sector in the world, with 63 million MSMEs contributing to over 30% of the national GDP and employing over a 100 million people in the country. 

Before we can address financial inclusion, we must understand the landscape of the MSME sector. Many are familiar with the $500 billion ‘missing middle’ credit gap for the MSME sector. However, according to IBEF, not many are aware that about  99% of the 63 million MSMEs are micro-MSMEs, while only 0.52% are categorised as small MSMEs and a meager 0.01% are categorised as medium MSMEs. 

Further, majority of micro MSMEs remain in the informal sector operating without proper registration of their businesses. The lack of the formalisation gap has exacerbated the credit gap because formal credit can only be accessed by registered MSMEs. 

For MSMEs to reach 50% GDP contribution as part of India’s economic growth arc, the focal point must be on supporting the micro MSMEs to make a quantum leap forward so that more of them can graduate to the small MSME tier. 

There are three vital points of concern that must be addressed to ameliorate last-mile financial inclusion of MSMEs, with technology simplifying many aspects. 

1. Stop using property collateral for business loans

Creditworthiness can be determined now on the basis of multiple variables, yet most lenders rely on property collateral or mortgage documents in exchange for a business loan--a practice that dates back to Roman times. 

According to a report by World Bank, less than 50% of people own residential property in India. This, in fact, limits access to business loans as many micro MSMEs are unlikely to have any property to pledge and often are seeking working capital loans in less than Rs 10 lakh amount to fulfill business growth needs. With revised risk-assessment methodologies possible today, newer lending models can emerge that do away with the old model of using property collateral in exchange for a business loan. For last-mile financial inclusion, lending organisations must innovate and shoulder the risk in a different way instead of burdening the micro-MSME entrepreneurs with the need for property collateral.

2. Eliminate human bias from loan decisioning

While creditworthiness can lead to a binary outcome, the loan decisioning still involves people making a decision often on the amount, tenor, and interest rate that they are willing to grant a borrower. It is nearly impossible for human bias to not affect this decisioning. 

Case in point is the fact that women-owned MSMEs form about 20% of the MSME sector, but contribute to approximately 40% of the overall $500 billion credit gap, says the world bank report. A report by International Finance Corporation (IFC) indicates that women business owners face higher rejection rates, and often receive a smaller loan amount with a shorter tenor than a male-owned business on the basis of the same business factors. 

Use of AI/ML can certainly support the removal of decisioning bias and grant the businesses a fair chance regardless of the entrepreneur’s demography.

3. Speed up the process

India is moving rapidly and consumer demand is slated to make India the world’s third-largest consumer market within the next five years. When it comes to extending access to credit, we need to do the same. Most businesses have to wait for about a month for their loans to be disbursed even after approval. 

For the MSME sector, a blended approach of using both technology and feet-on-the-street presence for verification with direct disbursements can shorten the turnaround time from loan-approval-to-loan disbursement. This is critical as micro MSMEs often run on a 2-3 month cashflow and lack of urgent working capital can impede their growth as they try to fulfill a large order, or need to expand their worker base or purchase raw materials. 

Change is happening and rapidly so in India. By fostering financial inclusion, we can not only pave the way for small business growth but also bolster the overall expansion of the Indian economy, bringing us closer to the $30 trillion milestone by the centenary of India's Independence.

(The article is written by Hardika Shah, Founder and CEO, Kinara Capital)