How Covid-19 Is Reshaping Lending For SMEs The eligibility filter has to go beyond the barriers of traditional lending decision-making which has already created a credit gap of over $400 billion in the SME category

By Deena Jacob

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The fortune of small businesses across the country was severely affected by the pandemic, resulting in them reeling under the pressure of drastically reduced cash-flow and thus desperate for a lifeline. In recognition of their vulnerability, the government of India has announced INR 3 lakh crore collateral-free loans to boost liquidity and to give them a fair chance of survival. However, to ensure that the government relief measures are effective, it is imperative to ensure that capital flows to the right businesses that can survive and thrive. This means the eligibility filter has to go beyond the barriers of traditional lending decision-making which has already created a credit gap of over $400 billion in the SME category.

However, we can see a shift occurring in lending that will hopefully help address this gap. Here are some of the ways that the pandemic has forever re-shaped lending for SMEs.

The emergence of cash flow based lending

Due to the advent of technology resulting in data analytics and artificial intelligence (AI) among others, there are diverse lending practices that are evolving. One such example is cash flow-based lending, which is the need of the hour to increase the flow of credit to the SME sector. However to avail this, SMEs need to demonstrate a stellar book-keeping practice such as filing returns, higher credit score and better banking habits.

The surge in digital

Post COVID-19, a big trend that will continue to be on the rise is the surge in digitization. Already we are witnessing the rise of digital payments and selling online even at the micro SME level. This reduces cash transactions and sheds light on the real-time cash flow of these small businesses. This data can enable them to secure loans from more formal channels rather than local money lenders. Secondly, through digitization, patterns can be drawn on working capital cycles and platforms that can predict when the shortfall is likely to happen. This will serve SMEs to prepare in advance to extend their business runway. We are also going to start witnessing the rise of contactless verification processes, where the SME can procure a loan without having to go to a brick-and-mortar branch of a bank. Customer service and guidance through chatbots and a more gamified (interactive) loan application process is also a new trend which reduces cognitive load for SMEs while applying for loans.

360 degree data aggregation and assessment

The SME segment is largely driven by cash and the UPI economy, thus making it immensely tough to provide proof such as bank statements and other mainstream reports for credit decisions. As a result, small businesses that are healthy and eligible are left out of the lending landscape altogether. A 360 degree data aggregation and consolidation to make a decision is the need of the hour. Terms, rate and the right amount of capital is critical and this can only stem from having data. A credit decision mechanism which evolves from the traditional bank statement data is essential. This process is already setting in and one such example that demonstrates this shift is the Open Credit Enablement Network (OCEN). Under this new ecosystem, OCEN will connect lenders and marketplaces to utilize and create a diverse range of financial credit products at scale.

The rise of specialist lenders

Specialist lenders who can create cash flow-based scoring models, with systems that are flexible to accommodate varying frequencies of repayment and who can add more value to help the business grow (such as predictive analytics, accounting tools, etc.) will have an advantage. Line-based products too will be favoured as interest outflow would be limited only to the drawn down part and there is flexibility to repay at any time. Specialized models such as point-of-sale lending and peer-to-peer lending are also getting more traction. Fintechs and neobanks are joining hands with banks to provide expertise on data aggregation, digitization and analytics to bring together a change in the way customers are assessed. This will go a long way in bridging the credit gap that exists in the SME segment, mainly because of the lack of data to make decisions in the traditional approach.

Fintechs and neobanks offer holistic solutions to SMEs. They provide not just bank accounts and loans but also many related services like helping new companies set up invoicing and bookkeeping, manage payroll, automating employee expense management, virtual cards, setting up online sites, setting up payment gateways, etc., all under one roof. Fintechs and neobanks have tech-first systems which are capable of accommodating changes (like moratorium) much faster. They are also more agile to adapt to new scoring models and using alternate data to make a lending decision. So there is a definite sense that neo-banking platforms and fintechs will gather more momentum and offer a better, more personalized experience, for the customer which is the need of the hour.

The tide is already turning and the shift is taking place. Hopefully, post-pandemic most of the challenges that SMEs faced when it comes to lending will be alleviated, thus allowing small businesses to have access to the best resources that will see them flourish and prosper.

Deena Jacob

Co-Founder & CFO, Open

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