Decoding The MSME Lending In The 21st Century

The MSME sector is poised to be the key to unlocking India’s economic development and rightfully so. The Ministry of MSME’s annual report 2020-21 uncovered that India has approximately 6.33 Cr MSMEs that contribute significantly to the country’s productivity and employment. Despite its significance and reach, the struggle to acquire credit has hampered the sector’s growth and establishment.

A report by the IFC stated that 85% of MSMEs remain underserved in terms of credit, and only one-fifth of these financing gaps were fulfilled by formal credit. The contributing factors to this issue are access, cost, and underwriting. Traditional lenders require MSME borrowers to provide credit history, formal records, business vintage, etc, which may exclude many small businesses from the formal lending ecosystem. Moreover, they are dispersed, which brings up a problem of reach and penetration for larger lending institutions. As a consequence, the MSME lending sector in India faced a credit deficit of INR 16 Lakh Cr. (as of Q1 2020).

With the pandemic providing renewed impetus to MSMEs to digitalize and formalize, proprietors are also becoming increasingly comfortable with having their business needs met digitally. The Reserve Bank of India estimates indicate, there is a wide gap that can be bridged through digital lending that relies on data-driven credit models. Recently, IT Minister Ashwini Vaishnaw stressed the need to create “an innovative digital platform — as powerful, seamless and robust as UPI — for providing quick and easy credit to MSME, small businessmen, and those at the bottom of the pyramid”.

This synergy of advanced technology and understanding on-ground challenges has the capability to create a more accessible and inclusive credit.

The Current Scenario

The ecosystem-based approach of digital lending has transformed both the supply and demand side of lending. As a result, an MSME proprietor’s lack of a digital footprint, formal documentation, and owned properties is not an impediment. Digital lenders assess a borrower’s creditworthiness with data mapped from economic behaviour, payment history, and other past transactions by leveraging data analytics and AI. These novel methods make for a more inclusive lending ecosystem.

Another method hitherto unseen is that of ‘verticalized underwriting’; digital lenders collaborate with aggregators in various industry segments to fully understand industry-specific needs and challenges and provide credit solutions that suit them.

Digital lending has also augmented the reach of credit; proprietors in small cities can seamlessly access credit that was previously available to them in only physical outlets that were out of town. This has been made even more accessible through ​​solutions like E-NACH, CKYC/OKYC, E-Sign, Video Sign. The cost benefits of the lack of physical infrastructure are also passed down from lenders to borrowers. All of this leads to a cost advantage to the lenders which translates to a lower cost of capital for the small business owner.

Open digital ecosystems in India like Aadhar and India Stack are the springboard for the proliferation of digital lending. As a guardrail for this rapid growth, the RBI introduced the Account Aggregator framework which aims to further simplify the process of disbursing credit digitally. The AA process streamlines the sharing of financial data by allowing financial institutions to share a customer’s financial information with lenders directly(with the customer’s consent, of course). This framework makes the process secure, transparent, and efficient while addressing a major challenge in the lending industry which is the fragmentation of data.

Road Ahead

As digital lending in India is still at its nascent stages, there is a need to regulate the landscape. These holes in the system were highlighted during the pandemic, as unregulated lenders flouted consumer protection norms, putting borrowers at more financial risk than they started with. Information asymmetry also remains a pertinent issue that needs to be addressed in order to unlock the full potential of digital lending in India. To address this, the RBI recently constituted a working committee to introduce a regulatory framework that aims to protect the borrower but at the same time does not curb innovation of the lender.

The shift brought about by digital lending is changing the optics of MSME lending. What was once an onerous and time-consuming task is now becoming an easily accessible business decision. Empowering the underserved through capital inclusion is a win-win-win situation; for the lending ecosystem, MSME borrowers, and India’s economy as a whole.