Why Digital lending is a Game Changer for MSMEs
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Indian MSME base is among the largest in the world, second only to China. The segment contributes significantly to the GDP of the country, exports and even creates vast employment opportunities. However, until recently, this sector was underserved by financial institutions owing to high risks, despite their proven growth record. This had led to more than 60% of the MSME segment turning to informal sources of lending, at unfavourable terms. Given that banks and other traditional financial institutions require credit history, elaborate documentation & proofs to assess the credibility of a loan applicant, a significant chunk of entrepreneurs and small business owners lost out on loan opportunities.
Digital lending: A game changer for the MSMEs
Over the last few years, the advent of fintech - especially digital lending, has been a game changer for the MSMEs. Amidst a positive regulatory environment and progressive Government initiatives, there has been significant growth of SMEs accounted for nearly 17% Y-o-Y growth last year. However, a huge chunk of the market with opportunity for digital lending is still left untapped. Studies anticipate 15x growth in digital lending to MSMEs by 2023, owing to rapid digitization and access to easier, cheaper credit facilitated by digital lending companies.
In the last year, Indian financial market faced a major setback with ILFS crisis, shaving off over $116.33 billion investor wealth. With IL&FS being a major infrastructure player, this crisis could have potentially triggered a bigger financial crisis, however swift reaction by the Government and the regulatory bodies contained the financial crisis.
Defaults by IL&FS resulted in SMEs in the country turning to NBFCs for their funding needs. Banks struggled with bad loans & low capital buffers, while non-banking financial companies faced higher rates in borrowing. However, digital lenders have overcome this fear of liquidity, the players in the fintech ecosystem have continued to raise large amounts of funds from corporate borrowers through NCDs & CPs.
Unlocking the power of Data
Digital lending is increasingly taking preference among MSMEs, given the ease of access and hassle- free processes of securing a loan, as compared to traditional sources of lending. NBFCs and leading digital lending companies rely on data of business performance and its financial health to assess loan eligibility.
Traditionally, loan applications were evaluated based on various types of financial information and documentation to a lender such as tax returns, credit report, payment history, bank statements etc. With increasing digital transformation of this data, digital lenders are able to quickly determine the type of loan and the interest rate for which the borrower is eligible. Digital data management and advanced analytics enable digital lenders in faster processing of loan applications.
The evolution of technology has caused lending to shift to modern & smarter forms to evaluate creditworthiness, causing the rise of alternate data. Large amounts of structured, semi-structured and unstructured data have been unearthed, owing to the increased penetration of smartphones, satellites, sensors, and websites enabling digital lenders to mine this information to make better data- driven decisions.
Going beyond formal sources of data such as bank statements, national ID card and even GST filings, alternate data derives insights into financial history through a digital evaluation of an individual’s habits. Some of the sources of data include Amazon, Facebook, Mobile, etc. among other minor
sources such as locations, restaurant visits, debit card details etc. Coupled with Machine Learning, digital lenders can verify the data provided by the loan applicant more efficiently. This provides MSMEs with better avenues of securing a business from, therefore enabling their growth.
NBFCs have identified various proxies for credit comfort to determine a customer’s intent to pay back a loan, the quality of his product/service, financial health of his business, and ability to survive with competition etc. This makes the application process simpler requiring only Bank statements and VAT/Service tax returns of the business as documentation.
Road ahead for digital lending
With 80% users being first time business loan borrowers with little or no credit history, technology will continue to be the forefront of digital lending, making it imperative to continuously innovate and deliver products that empower the larger MSME community. Today the success of any digital lending business depends on optimal usage of technology including machine learning and analytics. Today, digital lending companies are deploying a host of algorithms to improve and address repayment, delays and delinquencies data making it more robust with every repayment collected. Use of technology not only removes the last mile fraud and individual biases while sanctioning loans but also significantly reduces time and costs of credit appraisal, making the unit economics quite attractive.