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Adding A Dash Of Fintech To MSME Financing And Operations

The measures provided under the MSME stimulus package do not seem helpful in resolving such immediate issues that these business units are facing. It rather seems to want to nudge units to borrow widely, straddling an uncertain path to deal with this crisis.

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Fintech startup Zaggle has recently partnered with payments technology giant Visa to launch innovative payment solutions for SMEs in India. The collaboration focuses on easing cash flows to a sector hit hard by the national lockdown imposed due to the spread of the Covid-19 pandemic. The need for digitising their businesses has never been felt more urgently by the micro, small and medium enterprises (MSMEs). 

Finance Minister Nirmala Sitharaman recently announced 6 measures for the MSME sector, as part of the Atmanirbhar Bharat Abhiyan initiative. These measures included collateral-free loans, equity financing and subordinated debt with partial credit guarantee for stressed MSMEs, amongst others. A critical, common feature of these measures, however, is that it hinges on the premise that financial institutions will be willing to lend and that these enterprises would avail fresh loans. 

This premise seems rather aspirational considering trends inflow of finance proves otherwise. Formal sources are seen to service only around 16% of total MSME debt demand, implying a staggering 84% is financed from informal sources. These informal sources are understood to be mainly moneylenders or chit funds or other non-institutional sources such as social networks. For those looking to address their debt demand from formal sources, the lending scenario looks bleak. The MSME sector’s share in total outstanding bank credit stands at a meagre 5.37%, as of February 2020. There has also been a lowering in the credit exposure of the various MSME sub-segments over the past few quarters. 

What the MSME sector needs NOW

With outstanding invoices, working capital requirements and issues with cash flow, the MSMEs need quick short term liquidity for instant relief. For a sector marred by low creditworthiness, even in the pre-pandemic phase, it is questionable how much benefit medium to long term credit focussed measures will do. This is not to discount the importance of such measures. These will prove useful in the endeavour to propel further growth in the sector. The issue however is, it may not prove to be the appropriate measure to address immediate obstacles emanating from almost nil revenue generation in the past 2-3 months. These obstacles are primarily in the form of inadequate cash flow to buy material, payment of wages and monthly utilities such as rent and electricity dues. 

The measures provided under the MSME stimulus package do not seem helpful in resolving such immediate issues that these business units are facing. It rather seems to want to nudge units to borrow widely, straddling an uncertain path to deal with this crisis.

How fintech expertise can be leveraged by and for lending to the MSME sector

Fintech entities engaged in the business of lending typically bring efficiencies in the form of leveraging alternative data sources like SMS, information on promoters, psychometric profiling and analysis of spending behaviour. This leveraging of alternative data sources backed by tools such as Artificial Intelligence (AI), machine learning and data analytics can be particularly useful in lending to borrowers who do not possess adequate financial records or credit histories. Such entities are especially important for a key economic sector constrained by inadequate formal financing due to a risk-averse bank lending environment.     

Fintech solutions may be a key alternative in identifying viable players in this universe of micro and small enterprises and channelling adequate capital to them, especially working capital is the pressing need of the hour. Fintech lenders in the MSME sector today offer a variety of novel credit models, ranging from developing unique scores through automated underwriting algorithms for loan applicants, to the inclusion of an individual’s ‘intent-to-pay’ as a smart credit criterion apart from the general assessment of repayment capacity. 

Significant value addition in the operation of MSMEs is said to come from the adoption of digital payment technology and payment gateways. According to a recent report by a prominent fintech company, MSMEs expect fintech solutions to aid them in confronting the critical challenges pertaining to knowledge asymmetry, payments and accounting, among others.  

Enabling more fintech players in the market

This sector is salient to the health of the Indian economy. It contributes to close to one-third of the country’s GDP and half of the exports presently. It is unlikely that the endeavour to create an ‘Atmanirbhar Bharat’ will be successful without this sector getting back on its feet. A dated concern of the MSME sector has been inadequate financing of a secure nature. The need to ensure last-mile connectivity in financing such a vastly informal and micro enterprises-heavy sector cannot be overstated enough. 

India has over the years developed significant expertise in the design of fintech solutions. Fintech companies are more adept at providing customized working capital loans due to their enhanced technical prowess such as invoice based lending to MSMEs. This helps them to tide over the episodic shortage of working capital which is all the more important considering the straitened lending from formal banking channels. 

To enable further participation from fintech players, certain interventions will be necessary. For instance, the RBI ‘Enabling Framework for Regulatory Sandbox’ should be revisited to include ‘credit registry’ and ‘credit information’ within its ambit. The current exclusion of these two parameters renders these unfavourable for testing under the Sandbox. Credit information, for instance, is an important, alternative data source to build credit profiles of MSMEs that are known to be generally deficient in creditworthiness. Inclusion of these parameters would give an impetus to fintech companies testing products and thereby facilitate innovation in lending strategies and products. Further, it is imperative that MSMEs accelerate the pace of digitization of business processes in order to better adapt to a post COVID world with its emphasis on social distancing and remote working. Fintech solutions could also be particularly handy in a digital outreach to potential suppliers and customers while also adding value to day to day operational activities like maintaining books of account, marketing etc. 

These are some of the many measures that may be undertaken to spur fintech participation in MSME financing and operations. The goal, however, is to effectively tap into fintech expertise during this extremely testing juncture in MSME survival. 

Disclaimer: The views expressed in the article above are those of the authors' and do not necessarily represent or reflect the views of this publishing house. Unless otherwise noted, the author is writing in his/her personal capacity. They are not intended and should not be thought to represent official ideas, attitudes, or policies of any agency or institution.

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Amrita Pillai

Amrita is a lawyer and policy researcher currently working in the Department of Economic Affairs (DEA) (Ministry of Finance) Research Programme at the National Institute of Public Finance and Policy (NIPFP), New Delhi. She holds a B.L.S. LL.B degree from Government Law College, Mumbai and an M.A. in Public Policy and Governance from the Tata Institute of Social Sciences (TISS), Mumbai. Her interest areas include financial sector reforms and regulatory governance.

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Raghunath Seshadri

Raghunath holds a B.A. LL.B. (Hons.) from the National University of Juridical Sciences (NUJS), Kolkata, and works in the Department of Economic Affairs (DEA) (Ministry of Finance) Research Programme at the National Institute of Public Finance and Policy (NIPFP), New Delhi. He has been part of key research teams for Ministry of Finance instituted committees and groups such as the Report of the Steering Committee on Fintech Related Issues, 2019.

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