How Embedded Finance aligns incentives for MSMEs, platform aggregators and lenders

Shamolie Oberoi   /    Content Marketing Specialist    /    2022-02-07

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Your neighborhood corner store, the stationery shop opposite your office, your favorite local eatery.

These small businesses are an essential part of every Indian’s life - and at the same time, are vital to the smooth functioning of the Indian economy. They belong to the country’s Micro, Small, and Medium (MSME) sector that contributes a massive 30% to the Gross Domestic Product (GDP). The sector is a source of livelihood for approximately 110 million Indians and contributes to over 45% of the overall exports from the country.

Despite their essential role, however, they have been chronically underserved by the formal banking system. The sector is reeling under a credit gap of INR 25 trillion, with banks fulfilling their credit needs only about 40% of the time. 

Why aren’t banks lending to MSMEs?

There are two broad reasons why banks don’t disburse credit to this sector.

A (perceived) lack of data

Traditional lenders rely on credit bureau scores and past credit history in order to determine a borrower’s credit worthiness. But more often than not, MSMEs are first-time or thin-file borrowers who have little or no borrowing history to back them. Any data they may possess is highly unstructured and informal. Also, they usually apply for small-ticket loans, which doesn’t justify the time and effort required for a bank to underwrite them. It’s a vicious cycle - not having traditional data leads to limited access to credit, which further limits the possibilities of creating a credit score. Getting into the formal credit ecosystem can be next to impossible for these businesses.

A lack of security collateral

Smaller enterprises simply don’t have the resources to pledge security collaterals as a guarantee for a loan. But for many traditional, risk-averse lenders, this is non-negotiable. 

As a result, desperation often drives small business owners to borrow from informal lenders at exorbitant interest rates. In fact, 67% of finance supply for small businesses in India is sourced informally, driving them deeper into debt traps.

Is this an unfixable problem?

It seemed so, up until a few years ago. But as FinTechs emerged, they brought with them innovative solutions to broaden credit access to the underserved.

One such innovation - Embedded Finance - is set to open up revolutionary new ways in which small businesses can access formal credit. Platform aggregators, such as digital accounting apps and B2B E-commerce marketplaces can ‘embed’ credit within their customer journeys, offering financing options right at the point of demand generation. 

Here’s what makes this model especially effective

Captive user base

These platforms already have a number of SMEs but most of them are not able to transact all the time due to liquidity issues. Since the platform has a growing database of alternative data for each SME on its platform, such as purchasing patterns, cash flows, GST data etc. It is an opportunity for these platforms to partner with a fintech firm to underwrite their customers and offer credit within context. The platform can boost its order value by providing easily available credit to small businesses, which in turn can thrive and grow sustainably. The lender, as a capital provider, gets access to a new customer base. 

Advanced underwriting models

New-age Embedded Finance providers bring with them advanced underwriting models built on Artificial Intelligence (AI) and machine learning (ML). These models leverage real-time cash flow data, instead of static parameters such as salary or income, to identify risky borrowers and enable highly precise, automated decision making. This helps the platform offer differentiated products to MSMEs falling in different risk buckets, while the lender can price in risk adequately with varying interest rates. The MSMEs stand a chance to get a loan from a formal lender, albeit at a higher interest rate compared to others applying for a loan. If they pay this back on time, they stand a chance to move from a higher risk bucket to a lower one, progressively improving their chances of securing future loans.

PoS credit

Embedded Finance allows B2B (and B2C) platforms to embed credit at the point of sale. The borrower receives funds exactly at the point of transaction through a seamless process, and this boosts conversion rates and Customer Lifetime Value (CLTV). The business is able to place higher value and volume orders, the platform locks-in the customer and the bank cashes in on a potential borrower to nurture.

Quick turnaround times

Embedded Finance providers bring the entire lending lifecycle onto the partner platform. Thanks to deep platform data, users are prequalified and only then shown relevant loan offers. Once they apply, the process of underwriting takes a few seconds and the loan is disbursed within 24 hours.

Curated credit products

Access to reams of alternate data allows lenders to customize loans for each borrower, in terms of amount, tenure, and interest rate. This opens up the loan book to new-to-bank or new-to-credit customers. The platform can safely vouch that a majority of its captive users can get a loan. With a risk-focused approach, loan amounts are customized to the borrower's ability to pay, which helps borrowers repay on time, improving their credit profile further. 

Conclusion

As per estimates, Embedded Finance could expand the overall SME banking market by up to USD 92 Bn - proving that it could be what finally brings these small yet indispensable businesses into mainstream lending.

FinBox - a provider of digital credit infrastructure - enables platforms to embed credit and offer loans to their customers at the point of sale with a simple, low-code integration.

For instance, we worked with a leading B2B marketplace for electronic goods to roll out BNPL to its merchants without building it in-house. 

With its highly in-context B2B purchase financing solution, FinBox enabled the client to provide PoS credit up to INR 10 lakh. As a result, the platform witnessed:

  • 50% lift in Average Order Value

  • 250% increase in wallet share of credit as percentage of GMV

  • Doubling of GMV in just 2.5 months

If your business would like to enable in-context lending, reach out to us here.