How banks & MSMEs can take few steps closer to each to solve the credit problem

MSMEs are expected to contribute about 50% of India’s GDP in the next few years as we move towards our goal of becoming a $5 trillion economy. This presents an incredible opportunity to the banking system to tap into this rapidly growing and lucrative segment of the economy. Yet, commercial banks remain loathe to grow their exposures disproportionately to MSMEs.

Photo-by-rupixen.com-on-Unsplash.jpg
Photo by rupixen.com on Unsplash

It’s a much lamented fact that scores of MSMEs who constitute the engine room of India’s industry are starved of formal credit. India has over 6 crore MSMEs which employ 11 crore people and account for 29 per cent of GDP. Yet, as per a recent estimate, the credit gap to this segment is pegged at over Rs.15 lakh crore.

This is not to suggest that the banking system is not doing its bit to support this vital segment of the industry. According to RBI, total credit from Banks and NBFCs was over Rs.17 lakh crore in 2019 or 10% of total banking assets, which is a significant achievement given the sheer number of MSMEs and their small size and geographical spread.

As per the Government of India, MSMEs are expected to contribute about 50% of India’s GDP in the next few years as we move towards our goal of becoming a $5 trillion economy. This presents an incredible opportunity to the banking system to tap into this rapidly growing and lucrative segment of the economy. Yet, commercial banks remain loathe to grow their exposures disproportionately to MSMEs.

At the heart of this problem lies the informal nature of the MSME space and the absence of credible financial data about their business. This constrains a lender’s ability to assess and continuously monitor the MSMEs’ creditworthiness. Secondly, while MSMEs do offer to pledge their assets as collateral to banks, they are constrained by the value of collateral that they can provide. Finally, the small size of MSMEs and operations intensity of catering to numerous, small value transactions makes this business economically unviable for banks at scale.

As a consequence, MSMEs eventually meet their financing needs by borrowing from informal networks at usurious rates. This results in a vicious cycle of high financial costs, stunted growth and an opportunity loss, both for the country and for millions of job seekers.

However, there’s hope in the horizon ! While traditional banking is based on financial analysis and collateral provided by borrowers, there’s a new paradigm taking shape in the form of new age lenders who are creating tools to assess borrowers’ creditworthiness by using data sourced digitally – namely GSTN, Income Tax, Credit Bureau data etc. Surrogate data sources like digital data trails, transaction data on e-commerce sites, bank statement data are increasingly being crunched to make real time decisions on credit worthiness of borrowers.

So what can an MSME do to power its growth and access cheaper, larger loans from the banking system ?

As a first step, it is imperative that MSMEs become ‘visible’ to the formal banking system by
a) Aligning themselves with the Goods and Service Tax regime
b) Improving disclosure of financial transactions by adopting digital tools for transfer of funds
c) Offering credible declarations of business earnings and taxes paid

Availability of credible transaction data from such sources makes such MSMEs eligible for financing on Fintech platforms like Vayana Network who provides rich data analytics to banks on its platform. Partner banks and NBFCs on such Fintech platforms are increasingly willing to cast away their traditional lending models in favour of newer credit models based on surrogate data.

MSMEs providing increased visibility and credibility will also be able to access RBI approved invoicing platforms like TReDS who have tied up with large pool of banks who provide them the lowest possible cost of capital. Such MSMEs could to take advantage of most of the Government schemes which are mostly based on digital infrastructure and require beneficiaries to have some form of digital identity and presence.

On balance, the MSME credit gap is a problem which needs both the borrower and lender to adapt to changing times. MSMEs need to cast away their reluctance to enter the formal financial system, while banks need to view MSMEs in different light using newer tools being made available to them.

Do Gaz ki doori ? Actually not applicable here !

If anything, Banks and MSMEs actually need to take few steps closer to each other to solve this problem!

The blog has been authored by Parthasarathi Patnaik, Chief Risk Officer, Vayana Network

DISCLAIMER: The views expressed in the blog are solely of the author and TheSMEIndia.com does not necessarily subscribe to it. TheSMEIndia.com will not be responsible for any damage caused to any person/organisation directly or indirectly.