How UPI, digital lending are transforming the MSME sector in India

Micro, Small, and Medium Enterprises (MSMEs) are the backbone of most economies worldwide, playing a pivotal role in driving economic growth, innovation, and employment. These enterprises cater to a vast range of industries, from manufacturing and services to agro-based businesses. 

MSMEs are often hailed as the engines of socio-economic transformation, especially in developing countries. They contribute significantly to the GDP, foster entrepreneurial spirit, and generate large-scale employment opportunities. 

In India, MSMEs have been instrumental in promoting balanced regional development, reducing regional disparities, and ensuring a more equitable distribution of national income and wealth.

Digital lending and UPI as a pivotal component

Digital lending refers to the use of online platforms and technology to lend or borrow money. It eliminates the need for traditional banking procedures, making the lending process faster, more efficient, and user-friendly. 

The global digital lending platform market size exceeded $8.5 billion in 2022 and is expected to be at a CAGR of 20.5% from 2023 to 2032. This growth is propelled by the integration of digitisation in banking services and the rapid penetration of smart technologies, especially in developing countries. However, challenges like high dependence on traditional lending methods and lack of awareness in developing regions persist.

Unified Payments Interface (UPI) is a real-time payment system that facilitates inter-bank transactions by instantly transferring funds between two bank accounts on a mobile platform. Developed by the National Payments Corporation of India (NPCI), UPI has revolutionised the way transactions are done in India. It has become an integral part of the digital lending landscape, allowing seamless and instant loan disbursements and repayments. With features like 'Scan & Pay' and 'One-click Two-factor Authentication,' UPI offers a secure and efficient platform for digital lending, making it a pivotal component in the financial ecosystem.

In recent years, the integration of UPI with digital lending platforms has further streamlined the lending process. For instance, Bank of Baroda, an Indian public sector bank, announced in October 2022 that customers could apply for personal loans online through its digital lending platform, and leverage UPI for quick loan disbursal. Such integrations highlight the growing significance of UPI in the digital lending space.

The rise of digital lending 

Digital lending, as a concept, has been around for a while, but its true potential and widespread adoption have been realised only in recent years. 

Historically, lending was a manual process, heavily reliant on face-to-face interactions, physical documentation, and lengthy approval times. While there were tools to expedite certain aspects, the core of the lending process remained unchanged for years. Financial assets, for the most part, were paper documents, held by the originating companies or those investing in the loans.

The gradual shift towards digital began with the availability of vast amounts of digital information, automating loan origination processes that once required in-person meetings to determine creditworthiness. 

However, the true “Big Bang” event for digital lending was the global pandemic. The inability to transact in person accelerated the need for digital solutions. The infrastructure was already in place, and consumers quickly adapted, making digital lending the preferred borrowing method. 

Traditional vs. digital lending

• Traditional lending for MSMEs is complex and challenging due to issues like lack of collateral, poor financial records, and perceived risk by traditional financial institutions.
• The traditional lending process involves multiple face-to-face meetings, extensive documentation, and long approval waiting periods.
• Digital lending offers a streamlined approach, leveraging vast data to assess MSMEs’ creditworthiness and often providing instant loan approvals.
• The entire digital lending process, from application to disbursement, can be completed online, eliminating the need for physical interactions and reducing operational costs for lenders.
• However, digital lending comes with challenges like data security and privacy concerns, potential biases in automated decision-making, and increased competition, leading to compromised due diligence on some platforms.
• While traditional lending methods foster personal relationships and trust, digital lending provides a more efficient, scalable, and accessible solution, particularly advantageous for MSMEs.
• It is essential to address the challenges accompanying digital lending to maintain its sustainability and fairness for all stakeholders amidst its technological advancements.

UPI: A catalyst of digital lending in the MSME sector

How UPI Works?

• Initiation: A user initiates a transaction using a UPI-enabled application on their smartphone.
• Authentication: The user authenticates the transaction using a Mobile Personal Identification Number (MPIN).
• Transaction Processing: The UPI system processes the transaction in real-time, transferring funds between the sender’s and receiver’s bank accounts.
• Confirmation: Both the sender and receiver receive instant notifications confirming the transaction’s success.

Integration of UPI into Digital Lending Platforms

Digital lending platforms have integrated UPI to streamline the lending process, especially for MSMEs. Here’s how:

• Instant loan disbursal: Once a loan is approved, funds can be disbursed instantly to the borrower’s bank account using UPI.
• Repayment flexibility: MSMEs can repay their loans using UPI, ensuring timely repayments without the need for physical checks or bank visits.
• Real-time tracking: Lenders can track loan repayments in real-time, reducing the chances of defaults and improving the overall lending experience.
• Reduced operational costs: UPI transactions are cost-effective, reducing the operational costs for lenders and, in turn, offering competitive interest rates to borrowers.

Benefits of digital lending and UPI for MSMEs

Streamlined access to funds

• Digital lending platforms, integrated with UPI, offer MSMEs a streamlined approach to access funds.
• The Open Credit Enablement Network (OCEN) acts as a bridge between SMEs, Loan Service Providers (LSPs), Account Aggregators, and Lenders/Banks, facilitating smoother lending processes.

Cost-effective for lenders

• Digital lending reduces the operational costs associated with traditional lending methods.
• UPI transactions are cost-effective, allowing lenders to offer competitive interest rates to borrowers.

Instant loan disbursal

• UPI's real-time transaction capability ensures that once a loan is approved, funds can be disbursed instantly to the borrower's bank account.

Enhanced data availability

• With platforms like Aadhaar, GST, and UPI, there's a wealth of digital data available, making the lending process less complex and more transparent.
• Digital data aids in reducing both the cost and risk associated with SME lending.

Increased transaction volumes for LSPs

• LSPs embedded into e-marketplaces benefit from increased transaction volumes and earn commissions by distributing loans.

Security and trust

• UPI transactions are secured with two-factor authentication, ensuring the safety of funds and sensitive information.

Digital onboarding:

• Digital platforms enable swift onboarding processes, reducing the time taken to process loan applications.

Access to under-serviced customer segments:

• Digital lending platforms, combined with UPI, provide banks access to a large segment of MSMEs that were previously underserved or overlooked.

The future

• Continued growth of UPI transactions: With the increasing adoption of digital payments, UPI transactions are expected to grow exponentially, further integrating with various sectors, including MSME lending.
• Integration with advanced technologies: The integration of AI and machine learning with UPI platforms can enhance the user experience, offering personalized lending solutions for MSMEs.
• Global expansion: As UPI gains recognition, there's potential for its model to be adopted or integrated into payment systems in other countries, facilitating cross-border transactions for MSMEs.
• Enhanced security measures: With the rise in digital transactions, security will remain paramount. Advanced encryption methods and biometric verification might become standard features.
• Collaboration with Fintechs: Traditional banks and financial institutions are likely to collaborate more with fintechs, leveraging UPI for innovative digital lending solutions tailored for MSMEs.
• More regulatory evolution: As the digital lending landscape evolves, so will the regulatory framework, ensuring that MSMEs are protected from potential risks associated with digital transactions.
• Customised lending solutions: With the data collected from UPI transactions, lenders can offer more customised and flexible lending solutions to MSMEs, understanding their specific needs and financial behaviours.
• Financial Inclusion: UPI and digital lending platforms will play a pivotal role in financial inclusion, ensuring that even the smallest of enterprises have access to credit facilities.

Conclusion

UPI and digital lending platforms have brought about a significant transformation in how small and medium-sized businesses (MSMEs) handle their finances. 

They've made financial transactions quick and easy, bridging the gap between traditional banking and the modern needs of MSMEs. These platforms have also empowered financial inclusion, ensuring even the smallest businesses in remote areas can access credit and grow. 

Furthermore, they've increased efficiency, reduced costs, and provided secure transactions through encryption and authentication, fostering trust among MSMEs. It's a crucial call to action for all stakeholders, including financial institutions, fintech startups, and MSMEs, to embrace and adapt to these digital solutions. Doing so will not only improve borrowing experiences but also stimulate economic growth and innovation within the MSME sector.