Synopsis: The traditional financing process for MSMEs is time-consuming and often involves excessive documentation. However, with FinTechs dominating the financial market, the creditworthiness issues for MSMEs have drastically reduced. Read along as we discuss how they are doing it and paving the way for MSMEs to access finances. 

Micro, small, and medium-sized firms (MSMEs) are critical components of any economy, contributing considerably to employment and GDP growth. However, due to a lack of collateral, a poor credit history, or rigorous eligibility rules, small enterprises frequently require assistance securing loans from traditional financial institutions.  

According to estimates, the entire addressable credit gap in the MSME market in 2021 was almost Rs 26 trillion, having risen at a 37% CAGR. Its total addressable market demand was around Rs 37 trillion, of which banks, other institutions, and NBFCs contributed approximately Rs 11 trillion. 

The credit gap is the discrepancy in the external credit demand and the available supply of formal financing. Financial technology (FinTech) companies help bridge this credit gap in the MSME sector by introducing innovative ways to simplify access to credit. In this article, we will look at the role of FinTech firms in offering MSME loans and the advantages of using online lending platforms. 

Challenges MSMEs Face with Creditworthiness 

One of the most common challenges MSMEs face when applying for loans is needing more data to back their company’s finances and credit history. They might also need to show sufficient evidence of the company’s potential for growth. 

Here are a few more challenges that most MSMEs face with proving their creditworthiness and accessing finances: 

  • Collateral Requirements: Banks frequently require immovable property as security, limiting MSMEs’ borrowing capabilities. For example, a small textile business may need more land or buildings to pledge as collateral for a loan to purchase new gear or raw materials. 
  • Lack of Awareness: MSMEs frequently need more knowledge and awareness of the numerous credit programs and products available. They also need help locating qualified lenders and middlemen to help them through the procedure. For example, a small leather products producer may be unaware of the numerous government programs that provide subsidies, guarantees, or interest rate cuts for MSME loans.  
  • High-Interest Rates: MSMEs must pay higher interest rates and processing costs than large firms due to their perceived increased risk and weaker creditworthiness. This raises their borrowing costs and decreases their profitability. For example, a medium-sized food processing business may have to pay an annual interest rate of 13% on a bank loan. In contrast, a vast multinational corporation may receive a yearly interest rate of 5%. 
  • Complex Documentation: To obtain bank loans, MSMEs must submit paperwork and adhere to numerous rules, which prolongs the process. The required documents usually include proof of identity, residence, business registration, tax returns, bank statements, and audited financial statements. 

How FinTechs are Simplifying Credit Access for MSMEs 

According to The SME Finance Forum’s data, delivering new or updated digital financial products/services contributes to nearly 40% of FinTech interventions targeting MSMEs. FinTech companies are playing a leading role in assisting MSMEs to solve creditworthiness issues by leveraging their advanced digital capabilities and massive reach. 

Here are some innovating approaches through which FinTechs are solving problems for MSME’s in accessing finances: 

Offering Alternative Data Sources 

FinTechs have started using innovative credit scoring algorithms that leverage alternative data sources, such as GST reports, bank accounts, social media profiles, and mobile phone usage, to evaluate the creditworthiness of MSMEs. These models can overcome the constraints of standard credit rating approaches that rely on financial data and CIBIL scores.  

For example, many FinTech startups employ machine learning (ML) algorithms to analyze over 10,000 data sets from multiple sources to provide loans to MSMEs. The data contains a wide range of information, such as the nature of the business and cash flow patterns. 

Furthermore, many FinTech firms use ample data research to examine the digital footprint to determine creditworthiness. This works effectively with the required documentation, such as ITRs and bank statements, especially if the loan amount is significant. 

Providing Digital Platforms 

There are a variety of digital payments and invoicing options available to MSMEs that allow them to receive payments from clients, pay vendors, and monitor their cash flow online. Also, digitizing the lending process has provided FinTechs a platform to offer scalable solutions to MSMEs. 

FinTech companies, by deploying new-age technology solutions, can also ease credit access for MSMEs, helping them tap into a global market and increase their customer base and profits. 

These technologies also provide digital transaction records that can be used as proof of income and loan repayment capabilities. Ezetap, for example, is a firm that offers mobile point-of-sale devices that enable MSMEs to accept payments via cards, wallets, UPI, QR codes, and so on. 

Offering Customized Products 

FinTechs’ technology and digital capabilities enable them to customize products that match the cash flow needs of MSMEs and issue short-term, small-ticket loans. Such loan solutions benefit MSMEs that demand consistent working capital for expansion.  

Moreover, FinTechs, with their digital capabilities, can ensure that MSME borrowers have little documentation and a short response time. These companies can also provide unique benefits to their MSMEs, such as daily repayment plans, which make it easier for them to obtain loans.   

Aside from loans, a few FinTechs provide small businesses digital services marketplaces where they may interact with numerous digital solution providers across digital payment, digital delivery, and digital discovery platforms.  

FinTechs also provide customized products based on the borrowers’ working capital needs. They use emerging technologies such as data analytics and machine learning. 

Offering Flexible Repayment Options 

Many FinTech lenders, including MSMEs, have altered their onboarding requirements, providing loan repayment vacations or lower interest rates to their customers. Similarly, some more extensive financial services and e-commerce businesses have temporarily delayed business loan repayments to relieve cash flow strain on merchants affected by supply chain delays and weaker customer demand.  

A few FinTech corporations have provided direct financial assistance to MSMEs, such as cash grants or online advertising credits. Also, several crowdfunding sites have launched programs and initiatives to offer small company owners low-interest loans or gifts. 

FinTech providers offer new digital payment solutions for MSMEs to cope with transactions in a contactless way. Partnerships between FinTech startups and traditional payment service providers (PSPs) have also contributed to expanding MSMEs’ contactless payment alternatives.  

For example, Amazon suspended loan repayments for sellers in its marketplace, whereas PayPal allowed small businesses to defer them at no additional cost. 

To Sum Up 

By leveraging novel solutions such as digital technology, alternative credit sources, and advanced analytics, FinTech companies are simplifying the loan application process for MSMEs. This allows emerging businesses to get quick access to funds, which they can use to expand their operations.  

Also, this ecosystem of banks collaborating with FinTech is expanding. The finance ministry is collaborating closely with the RBI to close the credit gap in the MSME sector. According to reports, with the help of FinTech loans, India can reach its targeted GDP and grow to be a $5 trillion economy, as long as the MSME sector and smaller business owners are included in the mix.