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It seems to me that the number $267-334 billion isn't just the widely accepted MSME credit deficit but also the stuff of nightmares. It's hard to know whether this number is underestimated, overestimated or if it's even in the ballpark of an actual gap. Troubles compound once you ask the tough question of whether $334 billion will fix the credit gap forever or is it the first tranche of fund infusion needed and then there'll be a lending lifecycle to track and fund.
But, there's also a possibility that credit access for MSMEs could actually be better than it is widely perceived. According to the MSME ministry, India has nearly 64 million MSMEs. The top half rakes in revenues above ₹250 crores, and the bottom half consists of single-person operators like grocers, everything from commercial vehicle owners to village craftsmen.
The common perception is that only 6-10 million of these MSMEs have access to formal credit, but data suggests that it might be an underestimation.
A quick look at the MFIN website tells you that there are 55 million unique microfinance borrowers. Industry experts suggest that at least 25% of them are MSMEs. TransUnion & CIBIL data suggests that there are an estimated 14-16 million consumers with commercial vehicle and business loans. These also seem to be MSMEs.
That’s nearly 34-36 million MSMEs that already have access to formal credit.
The long tail of the MSME credit demand is from the other 30-odd million MSMEs.
A recent survey released by NeoGrowth Credit, conducted over two years, shows that loan demand from micro, small and medium enterprises (MSMEs) was back to 99% of pre-pandemic levels in non-metro cities by March 2022 but just 81% in metros.
While it may not reflect the average ticket size, it certainly reflects the industry’s grit to bounce back - small businesses are particularly contact-intensive enterprises and bore the bigger brunt of the pandemic as compared to large corporations. The survey reflects that given the right digital tools and financial assistance, economic prosperity can truly hinge on MSMEs.
What makes MSMEs run away from formal credit?
Businesses exist to make a profit. But every good business knows that financial liquidity, or cash flow, is far more important than profit.
Tighter cash flows = failing business.
In particular, MSMEs face bigger cash flow challenges since a major portion of their sales are tied up in credit to buyers and they don’t have as many financing options as larger enterprises. Delays in payments are the biggest challenge for MSMEs - nearly 5.9% of India’s gross value added (GVA) annually, is locked up in delayed payments to MSMEs (nearly 10.7 lakh crore).
There’s a consistent need for credit that it's often met by moneylenders, who tack on absurd interest rates, effectively stifling growth. Formal credit requires collateral, which devolves to a reliance on informal credit again. There’s also a lack of financial literacy, low familiarity with the digital lending ecosystem, aversion to paying taxes, and formalized business practices of following local and state compliances and registrations.
More importantly, however, informal credit has a quick turnaround time.
The current bank-driven lending model is unable to cope with the size and speed of these needs and also runs afoul of most risk managers. The lending process of banks is focused on large ticket-size loans owing to the cost and time required for underwriting.
As a result, MSMEs turn to NBFCs - they substitute banks’ ability to reach remote areas, they make quick credit decisions, offer prompt service, and are experts in niche segments. On the flip side, despite easy accessibility, NBFCs face a setback of charging higher interest rates and processing fees than banks due to their easier and more convenient financing options.
NBFCs’ interest rates need to cover their borrowing cost and the spread
Since they cannot provide overdraft facilities, their interest payable is higher than core banking institutions
LTV (loan-to-value) percentage for loan eligibility is higher as it includes stamp duty and registration of assets, unlike banks
The flexibility and convenience of faster turnaround are usually compensated by a higher processing rate.
This means that more often than not, banks and NBFCs can be a far more expensive option for MSMEs as compared to informal money lenders.
My colleague Devashish Mulye coherently elaborates on why MSMEs remain one of the most credit-starved sectors in the country and how fintechs like FinBox are frontrunners in closing this gap. Read it here!
MSMEs - the mighty mite
MSMEs are, without a doubt, the backbone of the Indian economy - 30% of India’s GDP contribution comes from MSMEs and they also account for 40% of India’s exports. Safe to say, a lot of economic prosperity hinges on the growth of MSMEs.
However, reliable and consolidated data eludes the behemoth sector.
For most fintechs touting the prowess of leveraging alternate data, it’s a problem waiting to be solved. It’s no different for us.
This piece by my colleague Shamolie is proof. She makes a case for using GST data to provide better insights into the health of an MSME and how it could potentially calm the jittery nerves of lenders.
And fair enough. Think about it, GST was introduced to enable the digitization of the entire indirect tax system. For fintechs, it means petabytes of data waiting to be underwritten.
On the same lines, I was also wondering what other innovations can come on top of GST data. And it struck me - an MSME that has formally registered and filed for taxes is proof enough of its health and the fintech scaffolding can come in the form of an instant credit line at the checkout.
Any credit product geared towards MSMEs should address the conditions they operate in. They face fluctuating demand, high cost of real estate, increasing demand for a wider range of products from customers, varying inventory turnover times, and supply chain inefficiencies.
For all the fine talk about how unorganized the sector is, the resistance to formal credit, and the inability to adapt to technology, MSMEs are probably one of the more agile and adaptable sectors. The same NeoGrowth survey revealed that nearly 66% of MSMEs are moving to online sales post-COVID-19.
The MSME credit gap might be an old piece of statistic but the problem is very much real. And so is the MSME grit to thrive in the face of adversity. The MSMEs propensity to adapt to new technology is just as good as any fintech, it just needs to be aligned with their intent and needs to be contextual.
That’s all from me this week.
As always, here’s a list of things worth reading for the week -
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See you next week!