This is How Financial Institution can Address SME's Credit-related Concerns
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The small and medium enterprises (SMEs) are the backbone every developing economy, including India. In fact, according to a CII report, the MSMEs contribute around 6.11% of India's manufacturing GDP and 24.63% to the services' GDP.
In spite of having so much potential, the sector is still unable to raise loans via financial institution like banks and NBFCs to accelerate their growth process. As per the recent Economic Survey 2017-18, of the INR 26k billion credit disbursement, 17.4 per cent was availed by MSMEs. Though the growth of credit to micro and small enterprises increased by 4.6 per cent, credit to medium enterprises decreased by 8.3 per cent.
The number speaks for the untapped credit demand of the MSMEs, which provides employment opportunities to more than 11 crore people. And before one starts with the blame-game, we need to understand the issues faced by the sector while raising loans from banks and NBFCs:
Risk Factor: In November 2016, when Prime Minister Narendra Modi announced the government's demonetization drive, MSMEs were among the worst hit sector as their businesses were cash based. The response was not just limited to demonetization but also during the GST.
Sunil Agarwal, Managing Director, PaisaLo, a BSE-listed NBFC firm, says MSMEs are exposed to market-linked volatility thus the credit risk is high.
Ticket Size: The typical need of a SME is around INR 10-20 lacs, as against a larger corporation which runs into hundreds of crores. The cost of servicing such a small-sized loan from a bank or an NBFC is very high and therefore, financial institutions are likely to avoid such requests.
Collateral: Additionally, to avail loans, one needs to offer collateral - a personal property or manufacturing plant or even machinery. Most the SMEs do have much to offer as collateral; hence lending firms view them as high-risk requests.
Financial Reporting: The SMEs also need to back their loan request with tax-returns, balance sheets and other financial documents which speak about the health of the companies.
Manish Lunia from Flexiloans says financial reporting until GST was introduced, was never a big hit in India and additionally, SMEs continue to deal with cash. The banks are aware of this situation, but they will never ignore it.
Granularity: This is a situation where the risk grading system at banks does not have the requisite capability to discriminate between good and bad risks. R.K Gupta, Executive Director, Bank of Maharashtra thinks this leads to a tightening of credit terms, or an increase in prices, or both.
"From the borrower's perspective, this leads to an outcome where the bank is over-pricing good risks and under-pricing bad risks," he shared while adding that, "The fact that most banks in India have not developed adequate expertise in MSME lending risk assessment exercises leads to the problem of granularity when it comes to MSME lending."
How can we bridge the gap?
The answer here is simple - Embrace technology advancements and collaborate with fintechs.
Financial institutions need to stop judging the SMEs with the same parameter that they use for large corporations. These lending companies can take a lesson or two from the fintechs.
For example, digital startups like Flexiloans ask for the point-of-sale report to assist retailers with their loan requirements or take an instance of Capital Float who offers professional loans to doctors to set up their independent practice or a medical institution based on their CIBIL score without any collateral.
A lot of banks have initiated conversation with these digital startups and have come with an innovative idea to address the MSME credit issue like for instance, A.Treds platform, a JV between M Junction and Axis Bank which allows SMEs to trade their invoices with banks and raise short-term loans.
But is this enough? In the past two-three years, fintechs alone have disbursed about INR 1 billion loans, Lunia thinks there is demand for everyone to carter. He suggests the union government should increase the number of players who could disbursement loan under the Prime Minister's Mudra Yojna (PMMY).
Presently, SMEs can avail loans under the scheme through commercial scheduled banks, rural banks, MFIs. In 2017-18 about INR 1.45 lakh crore was disbursed via PMYY.
Furthermore, with the implementation of GST, a lot of taxation reporting is done monthly. The reports can speak a lot about the health of the business. And therefore the government can consider releasing the data on an API, which can be used by banks, fintechs, MFIs, NBFCs to assess the creditworthiness of their customers.