Small Businesses in India Need Credit Support: Here's the Knowledge and Technology to Solve This
Banks in India are designed to serve the formal sector and their assessment is based on the balance sheet, P&L, tax returns and this leads SMEs to trouble
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No one can challenge the fact that lending to small and micro business is an untapped opportunity for lending institutions in India. The credit gap for SME / MSME in India has now ballooned to $300 billion and is growing at a CAGR of 7per cent.
One would wonder that for so many years why Indian banks and NBFCs haven't been able to tap this opportunity. Why have financial institutions historically been focussing on large corporates, real estate and mid-market but not on the SME/MSME sector?
The reason, to my mind, has to do with how we look at these businesses. Most of these businesses prior to the advent of GST were part of the unorganized segments. Owners used to largely transact in cash. They had their entire life savings invested in their business and had no additional collateral to offer.
On the other hand, banks in India are designed to serve the formal sector and their assessment is based on the balance sheet, P&L, tax returns. They have never built the ability to assess the capacity of the SME/MSME to borrow and repay and lack the ability to intelligently test the intent of borrower. This has led to the huge gap between the need for and supply of credit.
The SME/MSME landscape in India is highly complex and heterogeneous in terms of size, segments, activities performed. As the need for each SME is unique, financial institutions must relook their lending strategies to leverage those untapped opportunities.
Giving Importance to the Cash-Flow Profile and Aligning Repayment:
The cash flow profile of a playschool is different from that of an auto-component manufacturer. So, the key here is to understand the cash flows of small businesses and align repayments accordingly. However, to achieve this, financial institutions must deeply analyse each business. For instance, the cash-flow of an auto-component dealer usually goes down during the rains. Therefore, in monsoon, his repayment capacity will be lower. Financial institutions should take note of such aspects. Similarly, if a school receives fees once a quarter, EMIs of that school should be structured accordingly.
Assessing Future Credit Behaviour Differently:
The process of assessing the credit behaviour of an SME is mainly based on bureau scores, property owned and some financial metrics. Today, an extensive source of public and private data is available through APIs. These data sources enable granular verification of MSMEs and assessment of future credit behaviour. In addition, one can rely on the assessment of non-traditional factors such as the attendance of students in case of schools, electricity consumption in case of manufacturing units to estimate revenues, etc. to ascertain future credit behaviour.
Reducing Reliance on Property as Collateral:
SMEs are usually not in a position pledge property as collateral. However, most financiers provide LAP based loans in the garb of SME loans. The trend is not helpful for the SMEs as it restricts access to financing. Ideally, financiers should move towards underwriting different forms of collaterals like machinery, medical equipment and more cash-flow based forms of evaluation. Even when it comes to underwriting property as collateral, scrapping of data from various sources including listings, distress sales help in triangulating property values, leading to better underwriting.
Sector-led Approach to Creating Cost-Effective Distribution Models and Better Underwriting:
The distributed nature of customers increases the distribution costs of financiers. Although the branch-and-DSA model is the most followed one, it's time to develop newer and more cost-efficient distribution models. The sectoral approach to underwriting helps in building ecosystem-based distribution strategies, for instance, partnering with food aggregators to lend to partner restaurants using transactional data, collaborating with corporates to lend to their supply chain based on historical transactional data, partnering with equipment providers to lend to customers.
The sector-led approach to credit also increases the level of homogeneity, thus improving underwriting standards.
SMEs will be able to realise their potential if it gets easy and affordable access to finance. Some disruptions are required to change the status quo.
Other industries have evolved by tailoring their products or services to the specific need of customers. It's time that financial institutions in India innovate and condition themselves to understand the needs of this business and customise their underwriting accordingly.