The micro, small, and medium enterprises (MSME) sector is pivotal to fostering economic development, encouraging entrepreneurship, generating employment, and promoting financial inclusion in our resource-constrained economy. Unfortunately, the MSME sector continues to be saddled with financial bottlenecks, with a lack of convergence of availability, accessibility, and affordability of credit.  
 
As per the latest Standing Committee on Finance report, MSMEs, India’s growth engine, face a colossal credit gap of around Rs 20-25 lakh crores. A credit gap refers to the difference between the demand for the credit and its supply from the formal channels. In fact, the ACCA report interjects that this credit gap has been worsening over the last five years. Additionally, over 80% of the MSMEs have no access to formal financing. 

Non-Banking Financial Companies (NBFCs) have been trying to bridge this gap by boosting credit flow to the MSME sector. They are increasingly turning into the go-to lender for Indian MSMEs, as their quicker verification processes with customized loan offerings can help serve MSMEs more efficiently.  
 

Reasons for a Credit Gap

The RBI-appointed UK Sinha Committee has cited three primary reasons for this acute credit gap in its 2019 report: 

1. High risk to lenders due to risk of non-repayment over delayed buyer payments embedded in supply chains. [The value of delayed payments to the MSME sector increased to Rs 10.7 lakh crore in 2021, 81% of which is owed to small and micro enterprises.] 

2. The high expense of supplying credit to these enterprises is due to a lack of proper accounts and collateral maintenance. 

3. Poor credit depth in semi-urban and rural areas due to a lack of lenders who can offer loans at affordable terms.   

Besides, the underwriting systems of the traditional lenders are inept at accurately evaluating MSMEs. This is because they have a poor understanding of MSMEs’ business models and spend no time on the ground monitoring their performance. 

How NBFCs can be the Credit Bridge for MSMEs in India

NBFCs have, over the years, invested in indigenous distribution networks and products to ensure last-mile connectivity and a better understanding of customers in remote areas. They have been bridging credit gaps through the following techniques: 

1) Business Model 

Specialized NBFCs have designed different business models as per their segmented customers and offer customized products and services tailored to their needs. They have managed this by establishing effective sales and delivery channels.  

NBFCs have also developed credit assessment techniques and risk management capabilities to better adjudge MSMEs’ creditworthiness, thus ensuring faster turnaround times. This has further incentivized MSMEs to apply to formal credit channels for timely loans. 

2) Product Bundles 

NBFCs have managed to build customer loyalty and improve client retention rates by offering product bundles. This means that along with credit loans, they also provide non-financial services support. This differentiated product offering enhances customer service levels, thus leading to growth in the NBFCs’ portfolios. This increased asset size further enables NBFCs to borrow and lend more based on the balance sheet lending model.

3) Specialty Products 

Machine Learning techniques and data analytics enable NBFCs to customize their product offerings as per client needs. This becomes especially important in cases of small-ticket loans, which MSMEs prefer for an immediate cash infusion. NBFCs, in addition to working capital and term loans, offer other products not limited to small business mortgage loans, loans against card receivables, hypothecation loans, e-commerce loans, and loans against property.

4) Factoring 

NBFCs have a greater risk appetite for financing invoices hosted by MSMEs in part due to their advanced credit assessment tools. This ensures seamless operations by assuring MSMEs of additional working capital liquidity as and when required. The government of India has also been taking steps to onboard more NBFCs on its TReDS platform, which specializes in discounting receivables.

5) Digitalization 

Online NBFCs have digitized their lending cycles and built dynamic underwriting models. This, in turn, has enabled NBFCs to offer their services to the unbanked MSMEs through tools, including eKYC, e-signature, and Aadhaar-based verification.  

Furthermore, they also employ regional language chatbots, cloud computing, AI and ML techniques to speed up processes that can enhance the overall customer journey. 

6) NBFC Collaboration 

Many NBFCs have been collaborating with financial technology companies to generate leads and improve access to credit. These marketplace lending platforms typically innovate in unsecured loan options and dispense credit either directly or by acting as intermediates that match lenders with borrowers. They use innovative credit-scoring models, thus making their underwriting process very efficient and ensuring quick disbursals.
 
An example of such a financial company is Protium, which provides business loans to MSMEs using engineering-based finance and has developed proprietary scoring models to assess creditworthiness.

7) Supply Chain Financing (SCF) 

Some NBFCs have been fixing the credit gap by providing supply chain financing to MSMEs that sell products to corporations. NBFCs do this by digitalizing the supply chain ecosystem. They either develop their own innovative credit solutions or license external technology solutions as ‘Software as a Service’. SCF financing helps MSMEs to leverage their existing commercial relationships with corporates for their working capital needs.  

8) Mobile-based Financial Services 

An increase in smartphone and internet penetration has enabled MSMEs to incorporate electronic payment solutions in their business models. This transaction history has led to the creation of a digital footprint.  

NBFCs, therefore, use this footprint to better understand and evaluate the MSMEs creditworthiness and sanction loans accordingly.  

This further provides an impetus for MSMEs to continue to formalize and adopt digital technology, thus creating a virtuous cycle that enables lenders to gain more insights into borrowers’ credit profiles. 

9) Co-Lending with Banks 

RBI has recently introduced a co-lending model, which encourages banks and registered NBFCs to collaborate to provide loans to MSMEs based in priority sectors at affordable cost. This has enhanced the flow of credit to unserved and underserved sectors by benefiting from NBFCs’ greater reach and lower cost of funding from banks.  

10) Ecosystem-based lending 

This approach involves NBFCs partnering with digital ecosystems such as Amazon, Google Pay, and Zomato, and using the information available on these platforms with regard to MSMEs’ operations. A composite credit model can be created based on revenue and transaction business volume information. This allows for quicker disbursals of loans and dispenses with the heavy reliance on credit scores for a loan sanction. 

11) Financial Literacy 

NBFCs have been playing a pivotal role in organizing financial literacy campaigns that educate MSMEs about the importance of credit scores as well as provide information about the various loan product offerings. Such campaigns also accord an opportunity to MSMEs to provide feedback, thus enabling NBFCs to better understand their clients and offer customized loan products.  

12) Account aggregators (AA) 

NBFC-AA can access borrowers’ transactions at a single point. These architectures facilitate cash-flow-based lending and connect GST information to the AA platform. MSMEs can, hence, access short-term, small-sized credit loans based on real-time cash flow data. The lending NBFC can further be assured of repayment through a lien on future cash flows.  

It is expected that NBFCs will be able to further bridge the credit gap after joining the Open Credit Enablement Network (OCEN). OCEN aims to provide access to formal and cheap credit by onboarding banks, NBFCs, technology service providers, account aggregators, and underwriting modelers. 

Conclusion 

MSMEs growth has been impeded by economic, institutional, regulatory, and behavioral bottlenecks. While NBFCs, through their directed business models and tailored loan products, have succeeded in providing credit to MSMEs, there is a lot left to desire. There is a need for continued collaboration between NBFCs and FinTech companies to leverage their digital tools to ensure financial inclusion.  

At Protium, we are committed to supporting small businesses by offering business loans at attractive interest rates with minimal documentation. Call at 8828827800 to get in touch with us!