As India aspires to become a developed super-economy, the transformation of the MSME sector remains a prerequisite. Indian MSMEs contribute 8 per cent to National GDP, 45 per cent to manufacturing output, 40 per cent to exports, and provide employment opportunities which are second only to the agriculture sector. Some of the macroeconomic surveys suggest that the next impetus for growth in India’s economy will come from micro, small, medium-sized enterprises (MSMEs and startups).
The MSMEs have tremendous potential to be an important source of employment and entrepreneurship. However, lack of adequate access to finance has remained the biggest hindrance for MSMEs to grow, compete, and create jobs. A recent study reveals that a vast majority of MSMEs do not have access to finance and were self-financed. The reasons are numerous – insufficient operating information, financial illiteracy of small enterprise owners, small ticket size of loans, among others, this has resulted in a large number of MSMEs grappling with a shortage of funds.
Fintechs to boost MSMEs
The fintech companies are fast emerging as ‘one-stop-shop’ for all financial needs of small enterprises. The technological innovations have transformed the entire financial services value chain. Besides, the use of behavioural and psychometric information and social media traces has equipped several fintech companies and non-banking financial institutions in addressing the funding requirements for micro, small and medium enterprises in the country.
The fintechs are making inroads into financial services industry as innovator and enabler, robust enough to carry the risk of loans and recoveries. The innovative business models have enabled them to emerge as a catalyst for growth for MSMEs. Fintechs are helping MSMEs to become more bankable and independent by removing significant obstacles like quick access to financing. They are also free from regulatory, and legacy baggage, thereby, having a competitive edge over traditional banks.
The online lending platforms are witnessing several new entrants in the market offering novel financial products to MSMEs. The fintechs have paved a hassle-free route to efficient and customised credit products for MSMEs. The impact of fintech companies’ proficiency in lending processes can be measured in several tangible aspects. These include short-term online loan offering, quick loan disbursal, competitive interest rates, ease of securing small ticket loans, and low cost of the transaction.
The fintech lending in India is at nascent stage compared to global counterparts and is poised for enormous expansion. The details are self-explanatory – the MSMEs and an active start-up ecosystem are in constant need of credit, while banks are unable to meet this growing demand owing to reasons like high transactional cost and old business models, the need of the hour is to innovate products for mass market and address challenges such as lack of financial and digital literacy and restrictive policy measures.
Innovation in financial products
The debt financing for early-stage companies is virtually non-existent, while MSMEs also lack mezzanine risk capital products. The lack of debt financing options for small and medium entrepreneurs has meant that businesses grow slower and are less able to take advantage of economic opportunities. Another example where traditional bank lending hasn’t catered well to small businesses is lack of franchising financing frameworks. A strong emphasis should be laid to support and develop innovative financial products and franchisees.
MSME lending is a costly affair for financiers because the processing of each application calls for intensive fieldwork and high levels of scrutiny, making the market underpenetrated. Nearly 50 per cent of total application processing time is taken up in collecting the required documents. Therefore, one can witness an inherent aversion to formal financial services such as banks and online lending platforms on the part of small businesses. Hence, it’s imperative to increase digital awareness among the MSMEs.
The crucial role of PSU banks
As per the policy package announced by the government for stepping up credit to MSMEs, the public sector banks will facilitate specialised MSME branches in identified clusters/ centres where there’s strong dominance of small enterprises. This endeavour will enable entrepreneurs to have easy access to the bank credit. The public sector banks are being advised to open at least one specialised branch in each district for providing better service to MSMEs as a whole.
The cluster-based approach to MSME lending is intended to meet the diverse needs of the sector. This can be achieved by extending banking services to recognised MSE clusters. A cluster-based approach may be more beneficial in dealing with well-defined and recognised groups. In this approach availability of appropriate information for risk assessment and monitoring by lending institutions can also be achieved. Hence, it’s essential to ensure that PSU banks provide adequate lending facilities to MSMEs for their business expansion and working capital needs.
United Nations Industrial Development Organisation (UNIDO) has identified 388 clusters spread over 21 states in various parts of the country. The Ministry of Micro, Small and Medium Enterprises has also approved a list of clusters under the Scheme of Fund for Regeneration of Traditional Industries (SFURTI) and Micro and Small Enterprises Cluster Development Programme (MSE-CDP) located in 121 minority concentration districts. The PSU banks are being recommended to increase thrust on MSME financing and take appropriate measures to improve credit flow to an identified cluster
The credit rating for MSMEs
The credit rating of MSMEs by reputed credit rating agencies should be encouraged. This will facilitate credit flow to MSMEs and enhance comfort-level of lending institutions. The banks are recommended to consider these ratings earnestly while assessing the rate of interest for lending to MSMEs. It has been observed that a majority of MSMEs are not aware of credit ratings; hence it’s vital that an awareness drive is regularly conducted for owners of small and medium enterprises.
The regulators in developed nations such as the United Kingdom and the United States have been proactive in allowing fintech companies to grow and challenge the traditional players. It’s important to encourage an atmosphere in which innovation in financial services and products is predominant; this will immensely benefit MSMEs. The government, as well as the Reserve Bank of India, have put in place a host of enablers to facilitate digital lending in India. The initiatives include payment bank licences, Aadhar, e-KYC, e-Signetc, among others. All of these are meant to create a favourable environment, which would foster application, assessment and ultimately enablement of digital lending along with other traditional sources of credit to various sectors of the economy including MSMEs.
Ramesh Bawa, MD & CEO, IL&FS Financial Services Ltd (IFIN) writes this piece for the May 2018 edition of FICCI’s Financial Foresights.