The Role of the Alternative Lending Sector in India's Burgeoning MSME Landscape
MSMEs are the growth drivers for economies across the globe. In fact, Indian MSMEs contribute 38% to the country’s GDP and have registered a double-digit annual growth rate – more than three times the nation’s growth rate for any corresponding year – for more than a decade. The important role played by MSMEs in the economy was even acknowledged in this year’s Union Budget, which pressed upon additional credit support to this undercapitalised sector. However, despite multiple government-led initiatives such as the Credit Guarantee Fund Trust for Micro & Small Enterprises (CGTMSE) and MUDRA Yojana, the high-potential market segment often finds itself stuck as the missing middle in Formal Financial Institution’s (Banks and NBFCs) lending targets and focus.
Formal Financial Institutions face the challenge of capacity constraints – a branch manager would rather process 1 loan from a corporate or even a Medium Scale business but avoids the 10 loans from small businesses that will help him/ her achieve the same targets. Besides, the credit policies which are more often a poor replica of the Corporate policies and miss the nuance required in accessing an SME are laden with redundant documentation requirements and unreal expectations. On the other hand, complicated bureaucratic registration and extremely high compliance requirements also desist small enterprises from registering themselves and availing the benefits of government-led initiatives.
The Indian MSME sector is currently estimated to comprise a total of 51 million business units. The provisional data from RBI hints towards a collective debt demand of Rs. 26 trillion by these businesses, apart from the equity requirement of the sector which adds up to a total of Rs. 6.5 trillion. Contrasting these figures with 300 companies (less than 0.0006% of the aforementioned figure) that get 45% of the bank loans gives a clearer understanding of the overall landscape.
Banks have become cautious towards MSME-based operations
The lack of innovation and infusion of technology in assessment also results in escalated MSME-related non-performing assets (NPAs); according to RBI, nearly 8.32% of the total MSME loans through commercial banks during the last fiscal were deemed NPAs. Banks become more cautious towards MSME-based operations to avert such risks, as a result of which the utilisation of available credit guarantee and insurance schemes fails to reach its actual potential. There is also a need to deepen and widen the credit delivery, which is not possible without a higher degree of technological assistance.
This is where alternative lending companies, with their impetus on technology, step into the picture. By meeting the sector’s requirements of alternate underwriting models, minimal documentation, loan offerings without collateral requirements, ease of application and quick turn around time, these companies are fast emerging as the most viable and effective channel to meet financial needs for MSMEs.
Since most banks have poor history of lending to small businesses, unlike retail lending they have not yet built scorecards for assessment and a lot of decisions are taken with restrictive policies and individual judgement. The entire process involves physical visits in addition to a lot of paperwork, which causes needless delays in the approval process. Alternate lending companies, on the other hand, have been able to tap data from various sources to be able to profile a small business and is evolving underwriting models and scorecards to lend to the segment. They assess every loan applicant through highly-advanced data analytics and specialised algorithms with automated reasoning, evaluating hundreds of variables and raw data points to ensure the applicant’s authenticity, repayment capacity and intent to repay.
This quick yet detailed credit assessment makes loan disbursal swift, efficient, and paperless, allowing MSMEs to rapidly stimulate their business activity without delays. Such state-of-the-art technology is also now being tapped by formal banking institutions via PaaS (Platform-as-a-Service) to digitally underwrite their own customers.
Alternative lending companies can additionally prove to be pivotal given the enriched industry-centric data that they are building. Government can collaborate with prominent companies to better understand the financial circulation, requirement, and feasibility of niche market segments, therefore devising reforms that can benefit the overall ecosystem. Such collaborations will facilitate the creation of a highly-focussed MSME-centric strategy and stimulate the sector further for greater growth.
The MSME sector, at present, has been performing exceedingly well despite the challenges that it faces in the market. As the sector is empowered with more friendly state and tax laws, pro-MSME policy initiatives, and easier accessibility to financial capital through alternative lending channels, it will surely emerge as the major economic driver in the inevitable Indian growth story.