Borrowing money

Digital lenders: towards MSME inclusion

India now has over 100 million micro, small and medium-sized enterprises (MSMEs) following the inclusion of retail and wholesale trade in the MSME category by the government last year. This means that the wealth of more than 25% of households is tied to any policy change related to MSMEs.

According to a CRISIL report, more than 47% of micro-enterprises and 53% of SMEs have adopted digital sales platforms. Another report assessed that over 65% of MSMEs have integrated WhatsApp and video conferencing as digital tools in their daily business operations.

The use of digital media for payment collection, online sales by MSMEs and GST transactions has grown by 50-100% in recent years. Despite all this, the fact is that more than 90% of MSMEs in India are micro in nature (turnover less than ₹5 crore), do not have enough turnover to fall under GST or other taxes and do not maintain any formal form of record keeping of their finances. They still rely on savings, friends, family, and lenders to meet seasonal requirements for working capital or growth capital and fall short of needs most of the time.

According to a report by Global Findex, only 8% of the Indian population have borrowed money from formal sources, which may not be the result of choice, given that informal financing is expensive and sometimes considered embarrassing.

Over the past five to six years, digital lending has grown in prominence, supported by the success of a strong government payments infrastructure, booming e-commerce sales and customer base, and as a result, more than 50% of new bank accounts opened in the last five years have been opened by Fintechs.

The RBI has promoted several sandboxes to propel innovation in the MSME space. In addition, NITI Aayog’s recommendation on digital banking services for businesses are examples of policy-level thinking for the betterment of the MSME sector.

Digital lenders have really brought credit inclusion and formalization to the fore by providing widespread access to information, availability, transparency, and a hassle-free experience. They use data-backed proxy underwriting tools and cash flow-based assessments to sachet loan size and use cases.

MSMEs can now access loans based on their purchases and sales, discount their bills, borrow against their machines or even digitally pledge bullion. Data suggests that digital lending is one of the fastest growing fintech segments in India and has grown exponentially from a volume of $9 billion in 2012 to $110 billion. dollars in 2019 and is expected to reach $350 billion by 2023.

According to the Global Findex 2021 report, remoteness from financial institutions, lack of trust and lack of need were the most frequently cited reasons for inactivity in formal bank accounts in India. Adequacy and timeliness of funds are equally important reasons.

India’s private debt to GDP ratio is among the lowest in the world and really needs to increase to contribute to GDP per capita. Digital lending has both the potential to solve most of the challenges mentioned in the aforementioned report due to the ability to use new ML and AI architecture to efficiently distribute credit, minimizing fraud and error.

Integrated financing and ONDC

Embedded finance, as a category, now allows merchants to take out loans in real time during buying and selling journeys. This becomes a boon to many small outlets who can stock more, sell and pay lenders once the sale is made compared to the initial cash requirement in the past.

Payment collections in industries such as textiles and chemicals present significant challenges and invoice-backed financing proposals by the Trade Receivables Discounting System (TREDS) ecosystem and digital lenders provide discipline and release significant cash flows tied up in working capital.

The recently announced Open Network for Digital Trade (ONDC) is a promising framework that can take MSME credit and efficiency to the next level. The RBI is taking measured steps both to encourage digitization of lending processes and at the same time to verify customer-centric data and components to ensure sustainable growth of the ecosystem.

That said, formal credit penetration for MSMEs is well below its potential. The MSME credit culture in the country has a history of higher late payments which further precipitated with demonetization, GST, IL&FS crisis and the continuing Covid pandemic, breaking the backbone of this segment .

The cost of financing for digital lenders remains high, as banks and NBFCs charge very high rates for these on-lending, making low-cost financing for MSMEs difficult. The availability of consent-based digital data like GST, banking information, transaction data is still in its infancy making it difficult to take out lightweight files even with surrogate data. The business KYC process is still a high friction process compared to consumer KYC and is an area that requires particular attention to viably extend small scale credit to MSMEs. Prospects for MSMEs to gain affordable access to finance are promising due to the government’s continued focus on making these businesses competitive, digitization of business records such as GST and digital payments, and programs such as Mudra and CGTMSE by SIDBI.

Fintech players are now tapping into low-cost funds through the co-loan mechanism, which could be a game-changer in the near future for MSMEs. Much greater support is required from government and stakeholders to encourage digital lenders and digital lending modeled on priority sector lending and initiatives like UPI.

Digital lending can unlock a very strong culture of formalization in the economy which has tremendous benefits.

Industry needs to focus on educating MSMEs about the benefits of formal finance, better litigation mechanisms to deal with willful defaulters and early warning signals, stronger banking and fintech partnerships to deliver inclusive finance as catalysts for the digital credit revolution for MSMEs. This is very important in propelling the country towards the goal of becoming a $5 trillion economy and beyond.

The author is co-founder of

Published on

July 17, 2022