By Mr. Nirav Choksi
India is climbing up the ranks to reach the position of the world’s third-largest economy very soon.
As the nation plans to improve that standing over the next 25 years—the unhindered growth of the Micro, Small, and Medium Enterprises (MSMEs) sector will be critical for India to achieve exponential scale and retain its position as an economic superpower.
While MSMEs have been treated to generous priority sector lending obligations in recent times—the sector continues to be a tricky segment for the financial ecosystem to serve.
With a projected doubling of digital SMEs in the next five years, the anticipated demand for working capital is expected to reach USD 570 billion.
Close to 95% of the credit demand arises from micro and small enterprises.
Many of these small businesses are faced with difficulties in raising capital due to inadequate business metrics and limited assets. There is a lack of reliable data relating to MSMEs’ financial health. Owing to this, there is a high level of information asymmetry—making the assessment of MSME creditworthiness quite a challenging task for traditional lenders.
The plight of thin-file MSMEs
Thin-file MSMEs often face restrictions with traditional credit scoring data, hampering their ability to secure funds on time.
On the other hand, many conventional financial institutions tend to focus mainly on serving super-prime and prime customers—in turn, overlooking the MSME segment.
From a broader point of view, the inability to understand the diverse needs of the MSME sector coupled with factors like rigid lending and repayment norms have slowed down the flow of capital to these businesses.
This scenario presents an opportunity for FinTech companies to tap into lower-income groups by leveraging digital solutions.
A call for FinTechs to revolutionise credit assessment with innovative models
The demand for unsecured loans from these thin-file businesses has seen a substantial 73% year-on-year growth.
MSMEs’ increasing reliance on digital platforms results in a digital trail of financial transactions. New-gen FinTech firms tap into this wealth of data to assess creditworthiness efficiently and offer immediate working capital financing solutions.
FinTechs are harnessing alternative credit scoring data derived from diverse sources, including digital footprints and comprehensive public records.
By leveraging advanced algorithms and alternative sources of data, FinTechs can:
- Automate tasks that were previously manual
- Speed up and enhance credit underwriting workflows
- More importantly, offer alternative financial products and services that are more economical, quick, and scalable
Alternative data sources allow deeper insights into customer finance and considerably improve credit underwriting. Analysing a broader spectrum of user data across various channels—FinTechs are uniquely positioned to attain more precise insights into the financial stability and debt repayment capacity of borrowers.
By leveraging data-driven underwriting tools and cash flow-centric evaluations, we are witnessing how FinTech lenders are providing reloadable and pay-as-you-use financing and sachet-sized flexible loans to address the immediate capital needs of MSMEs.
Moreover, innovative digital solutions like cluster-focused funding, point-of-sale-linked lending, peer-to-peer, invoice-centric, and cash flow-driven lending provide more flexibility for new-to-credit and thin-file customers, enabling them to get access to credit and build credit histories.
Digital lending in India has taken off faster than we predicted
FinTechs are keen on leveraging new data sources to assess the creditworthiness of MSMEs in the country. As a result, they have ushered in a systemic change, making the entire lending process paperless and in many ways, presence-less.
Consequently, digital lending has evolved significantly in the last decade, experiencing substantial growth driven by embedded lending, data-driven loan targeting, and innovative FinTech models.
There has been a 12x spike in digital disbursements in India, and this trend is only set to grow in the coming months.
In 2024 and beyond, AI-powered underwriting and enhanced automation will speed up digital lending processes, resulting in high rates of faster, error-free approvals.
Backed by smart integrations with data providers—FinTechs are enabling intuitive digital journeys and contextual product placements at the points of need to provide MSMEs with timely credit.
The need for an ecosystem-based approach
Addressing the substantial $530 billion credit gap for MSMEs requires a strategic blend of traditional bank and NBFC credit facilities alongside innovative financing solutions from emerging FinTech lenders.
Taking an ecosystem-based approach and developing a synergy with digital public infrastructure will be crucial in further augmenting MSME lending.
By synergising efforts—banks, NBFCS, and FinTechs can co-create efficient and tailored approaches to cater to the unique needs of MSMEs, leading to mutually beneficial outcomes for all parties involved.
This dynamic collaboration can play a pivotal role in fostering the growth of the MSME sector.
Bottom line
The concerted efforts of the government and regulators are urging financial institutions to scale up sustainable digital lending practices and foster financial inclusion initiatives. The focus of these initiatives spans security, digital client onboarding, customer convenience, and dispute management.
This transformation also involves deploying personalised underwriting strategies tailored to specific market segments, harnessing alternative data sources, and implementing credit decisions based on scorecard analysis.
The capabilities and technology to engage MSMEs and profitably meet their specific needs are broadly available to financial institutions today. The opportunity now lies in adopting these technologies and new ways of working to serve the segment successfully.
This will require banks to make the MSME segment a genuine priority. Armed with AI capabilities, a data-driven approach, and mutually beneficial collaborations with FinTechs, banks can build an appropriate credit-worthy cohort of potential borrowers.
(The author is Mr. Nirav Choksi, CEO & Co-founder, CredAble, and the views expressed in this article are his own)
