Cash Flow-based Lending Could Ease MSME's Struggle for Capital MSMEs required INR 32.5 Trillion of financing , of which around 78% came from informal sources

By Pankaj Gindodia

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In recent years, India has made huge strides towards financial inclusion through digitization of it's economy. Some of the initiatives that have contributed to this are:

  • Providing unique identification to every citizen through Aadhar Number

  • Opening Jan Dhan Accounts

  • Demonetization

  • Introduction of GST and return filing based on digital invoice matching

  • Launch of Payment Banks

  • Enabling Payment transactions through a fingerprint/Aadhar Number

The government has also taken steps to improve the ease of doing business by:

  • Disbursing small loans through MUDRA Bank

  • Repulsing of archaic laws

  • Introducing Insolvency and Bankruptcy Code

While these changes have been noted and appreciated the world over, rising NPAs are leading banks to be cautious about financing businesses, especially the MSMEs who do not have the right credit profile.


A big chunk of the Indian Economy is fuelled by the MSME sector, and around 100 million people are employed by the same, contributing around 35% to India's GDP. According to International Finance Corporation, MSMEs required INR 32.5 Trillion of financing (2012 figures)*, of which around 78% came from informal sources, with the rest coming mostly from banks and some from NBFCs. According to ADBI report, banks, NBFCs and the new age Fintech firms have an opportunity to finance these MSMEs with reasonable interest rates, which will further boost the economy.

"Cash Flow based Lending', as against traditional "Asset Based Lending', can aid the lending cycle and add to the fast-growing Indian economy. It can help FIs lend to MSMEs, who do not have significant assets/collateral to pledge but have good cashflows. Flows give the lender a better visibility on an MSME's trade profile that helps in making an informed decision on the lending and minimizing risks, rather than worrying about NPAs and then having to dispose off the defaulters' assets, as is the case with Asset Based Lending, and the current experience of India banks with NPAs.


Two major hindrances in getting a business loan today are the number of documents required and the time (at times as long as 3 months) involved. These are reasons due to which financing by informal sector scores over the formal sector, despite the heavy interest rates.

In India today, with the nationwide implementation of GST and India Stack; and with the advent of aggregator platforms - information of a business' cash flows can be procured electronically and in real-time, enabling loan decisions and disbursement in an easy, quick and programmed fashion. KYC checks can be done online with the help of Aadhar authentication.

Fintech firms can help give the banking experience and the whole loan journey on a simple mobile app/website. FIs can increase their reach to the hinterlands. The need for submission of collateral and income documents for small ticket loans for MSMEs is reduced, with only basic KYC documents required to comply with the regulations. The implementation of an all India Direct Debit platform - NACH - helps the FIs recover funds electronically and regularly without depending on the arduous process of PDCs.

This also means that the operating costs of the FI with respect to decision-making, disbursement and recovery gets reduced significantly. In addition, the risk gets diversified over many companies across regions, as against concentrating the risk on a small number of large corporate, while helping it increase the loan book size. It also gets entry to a less competitive market and can then start cross-selling other products like Salary Accounts, Consumer Loans and some of it's other financial investment products.

This will build a good credit history for the MSMEs, which in turn will help them get bigger loans in the future for business expansion, even from the formal sector, at reasonable interest rates.


Under the current scenario of mounting NPAs and court cases, it might be a challenge to convince banks to adapt to a new approach to financing, especially for borrowers with almost NIL credit history. Rising concerns over Privacy issues might discourage some users from providing their Aadhar details for e-KYC. The GSTN is still getting stabilized, and this may cause issues in fetching information electronically, delaying the loan disbursal process.


There is a huge untapped market for lending; and Fintechs and FIs can collaborate to capture and service this market, giving a fillip to the growth of the Indian economy.

Pankaj Gindodia

Product Manger - Vayana Network

Pankaj has 7+ years of experience in the Banking industry. Previously with Fundtech, he handled the implementation of SCF product in 3 leading banks in and out of India. He was also involved in the product and pre-sales activities related to SCF. In his current role with Vayana Network, he is a part of the product team, handling new product development activities, daily operations and interacting with FIs and Corporates for their onboarding and integration processes. Pankaj’s hobbies include sports and travelling.

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