How Companies are Leveraging Technology to Ease MSME financing
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It is a known fact that MSMEs are important to the economy, in terms of the employment, their contribution to the GDP and the exports. Still, the fact that there is a perennial capital constraint restricts the ability of this sector in achieving its full potential.
Even if a fourth of these MSMEs can be made financially stable, it would result in bringing a tremendous shift in the employment levels of our country and the consequent multiplier effect which it will have on the levels of personal income GDP.
MSMEs and Their Functioning
As per the data revealed by the economic survey, a majority of these MSMEs are sole proprietorships, hence, they are limited in their managerial, marketing and operational skills. Apart from the rules and regulations of the banking industry, which require certain hygiene parameters to be met in determining creditworthiness and the costs incurred in servicing MSMEs, it does not make a viable business case.
For e.g, any loan proposition has to go through the process of evaluation, creating an appraisal note, sending the proposal to senior and then finally a decision is taken whether to disburse the loan or not. This whole process takes a minimum of 1 month which is detrimental to the financial health of the MSME.
Now if you put this process to the 42 million odd MSMEs in India we know where the problem lies. It is simply not possible to scale up a process, thus it is imperative that we make use of fintech in overcoming the twin challenge of cost and reach. Even for the loan seeker, it isn’t possible to go to every possible financial institution and seek the most favourable terms.
In India, we have now data grade connectivity even in rural areas and with the help of even basic KYC, we can extend banking to these entrepreneurs.
The interesting aspect which many of us have missed is the per sq. foot revenue which this small establishment generates would definitely beat some of the best retail chains. Not just that, the share which each employee gets of the revenue is way higher than what is possible for organized retail to achieve. Couple all of it with easier finance and we have a goldmine which is yet to be explored.
The issue is not about regulation but finding alternative credible means to establish the repaying ability of these micro-entrepreneurs, these unsung heroes of our economy whose employment generation capabilities can sustain our ever growing working population.
TReDS and the essential role of factoring
My colleague was recently part of a conference where innovative ways to finance SMEs in Asia was discussed. The response which he received was no less than a pat on our backs, as his team was surprised to know that the audience, which comprised of international banking community was yet to see an online invoice auctioning platform running successfully anywhere in the world. This was a forum where we had representation from economies where factoring plays a huge role in trade finance.
While factoring has been a very actively used method of trade finance, auctioning of bills to financiers with full knowledge of the buyer is a relatively a new concept.
I can say it with pride that in TReDS, we have not only found a viable solution but also leapfrogged into digital invoice discounting before many of our developed counterparts could even experiment with it.
In our first year of operation, we have seen modest success with the model and continue to see traction among large corporates, the most important cog in this chain of trade finance.
It is through timely interventions of the govt. Policies and efforts have been undertaken to support MSMEs. The govt. in the last couple of years has come up with various initiatives such as standup India, startup India, mudra loans and Udyog Aadhaar to name a few, I feel it is our duty as bankers and citizens of this country to find innovative ways where we can fund the serious business and build checks to keep out the non-serious players.
The concept of TReDS was inspired by NAFIN which was established in Mexico to ensure timely payments to MSMEs. In Mexico, it was made mandatory for all the corporates to register on the platform and ensure that MSME payments were routed through it.
The transaction process on TReDS is called factoring, it is a financial transaction and a type of debtor finance in which a business sells its accounts receivable (i.e., invoices) to a third party (called a factor) at a discount
As per the RBI guidelines the platform needs to onboard the buyer, which is a large corporate and the corporate then refers its suppliers. Once the buyers and suppliers are on board the process of factoring or reverse factoring can start with uploading of the invoices by any of the parties. The uploaded invoice becomes a factoring unit and is available for auction. The financer with the lowest bid gets to discount it and the money gets credited to the suppliers within 48 hours.
The funds disbursed through a TReDS platform are eligible for PSL accreditation and come to the suppliers without recourse. These payouts do not show up as liabilities in the buyers’ balance sheets and thus optimize his cash flows.
The whole model of TReDS as envisaged by RBI benefits all the stakeholders and with features such as API integration with the ERP, straight through processing of invoices is possible or simply put the user (large corporate/MSME) does not have to leave their ERP/accounting software to initiate a transaction on the Invoicemart platform.
TReDS is enabling financial inclusion of MSMEs by providing them finance in a time-bound manner along with creating a digital trail of the transaction which could be used as a metric to ascertain creditworthiness.
What we need in near future is the further participation of smaller establishments and transactions among MSMEs to also be brought under the ambit of TReDS.
There is an untapped potential of over 13 lakh crores worth of trade finance which needs to be met and can be potentially serviced by alternate lending platforms such as Invoice Mart.
The government has been keenly looking into the performance of TReDs platforms and its efforts to integrate these exchanges with GST would be a first of the steps to formalize the possibility of using the transaction data as a new metric to evaluate creditworthiness.
TReDS needs to achieve critical mass soon and ensure that the benefits are percolated to all the MSMEs in the country.
Technology playing a pivotal role in MSME financing
Our country which currently is reaping the benefits of demographic dividend needs to provide jobs to millions of youth which will be coming out of colleges, it is not possible for the large corporates or the government to provide generate employment at such a fast pace. Hence it is important that we as bankers take on the task of nation-building by finding more innovative ways to ward off the epidemic of jobless growth.
In a recent report published in a leading business daily, it was said that India would turn old before it can see wealth. This again is an alarm bell for us, we need to act before it is too late and we don’t need to look too far. Our friend China over a number of years has successfully pursued the policy of development of MSMEs through various initiatives and we all have the results to see for ourselves. Our neighbour Bangladesh gave birth to the SHG movement which helped in alleviating women out of poverty by providing those loans to set-up business.
Technology has been a great equalizer, which has allowed multiple startups to be set up in the fintech space focused on providing finance to MSMEs. Alipay in China and Cabbage in the UK are a few examples which have been able to successfully lend to MSMEs on basis of the history of their trade receivables.
There is a long list of start-ups which have been set-up in India and are trying to scale up their model. For a real impact to happen, all these startups need to come on a common platform for knowledge sharing as many of them are using non-traditional ways of assessing risk. Over a period of time, this data of creditworthy MSMEs would be generated and it would become easier for such MSMEs to access finance.
The important task among these various initiatives which are being undertaken is how serious we are in tackling the problem of unequal distribution of wealth and for how long as a nation can we afford to ignore the problem or blame the govt.
There hasn’t been a time in the history of mankind when we have had all the access to technology, information, intellect, and even finances. What we require now is simply a commitment to make our country truly great by ensuring that many small businesses become financially stable rather have a few unicorn start-ups and MNCs setting up manufacturing plants here.
All of us saw the kind of effort which was put in saving the young players of a football team from a cave in Thailand. One of the divers by the name of John Volanthen said, “I dive for passion and always wondered if it would have a purpose.