“Digitalization and formalization in industry has brought a paradigm shift in the MSME borrowing model”

By Arun Poojari

Credit and financing for MSMEs: Today, the digital ecosystem signifies its ability to overcome fundamental barriers to the advancement of finance for inclusive and sustainable development. New era banking solutions have evolved from conventional brick and auto branches. From neobanks to e-wallets, buy-it-now, pay-later (BNPL) and no-fee EMIs, there is a radical transformation in the spending, lending and borrowing patterns of the economy.

The government has taken a conscious approach to lead the country towards a digital economy. The new wave has bought a paradigm shift in the borrowing model of MSMEs as they adapt to the digital ecosystem.

Traditional and alternative financing methods go hand in hand

MSMEs have mainly struggled to be part of the traditional finance system due to insufficient collateral, low credit ratings and small bills. Because of these issues, they did not qualify for traditional loans and resorted to private lenders, charging them much higher interest rates. With the mounting losses due to lockdowns caused by the pandemic, small businesses have started looking for alternative financing options.

Supply Chain Finance (SCF) has proven to be an excellent method to solve problems for MSMEs and provide them with access to finance to overcome their working capital issues at competitive interest rates. In the process, typically, buyers initiate financing requests and sellers receive upfront payment from banks and NBFCs on their invoices. While the SCF had existed formally and informally for decades in India, digitization has accelerated its reach and impact.

The Peer to Peer (P2P) lending model is hugely successful for alternative finance worldwide and is also gaining traction in India. Borrowers are onboarded and verified on P2P lending platforms, where financiers can view full borrower details before lending them money. The bidding process creates an open market for all entities. The Reserve Bank of India (RBI) has introduced the Trade Receivables and Discounting System (TReDS) and small financial banks to support small businesses and strengthen digital ecosystems.

Alternative Data – The Bridge Between Traditional and Alternative Funding Methods

Digitization has made the SCF process transparent, and the open structure raises the bar for transparency and accountability for all parties to mitigate risk. The ecosystem encourages invoice auction processes that help borrowers and lenders grab the best deal.

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Since small businesses carry higher risks, conventional lenders need to closely monitor repayment patterns and perform periodic risk assessments. Alternative data connects traditional and alternative financing methods by providing in-depth insights into customer behavior and business projections.

Digital SCF platforms excel in artificial intelligence (AI) risk mitigation techniques, and machine learning (ML) models provide deeper insight based on dynamic factors. They are not limited to credit scores alone. The models consider time sensitivity and seasonality factors when assessing risk using alternative data such as inventory, GST data, reimbursement models, invoices, etc.

Lenders identify debtors’ borrowing habits, repayment potential, and creditworthiness by leveraging advanced technology, data analytics, demographics, and social and financial behavior.

Final Thoughts

At present, where there are various online payment methods, customers are not limited to opening accounts with a particular bank or NBFC. Digital payment channels provide innovative solutions and win over a large customer base. Banks do not own these customers, but can offer banking and financial products such as loans, insurance, supply chain finance, etc. to this segment.

Also read: ECLGS: 1.19 crore MSMEs, other businesses benefited till June 2022; Rs 3.48 lakh cr loans sanctioned

The ease introduced by new-age digital media is changing borrowing habits and encouraging digital adoption. Traditional banks, NBFCs and smaller financial banks are partnering with fintechs to provide anchor funding and peer-to-peer (P2P) lending solutions.

MSMEs are getting much-needed help from new era startups. Fintechs have become key intermediaries to bring them into the formal credit system, facilitate the flow of alternative credit to small businesses, and change their borrowing habits.

Arun Poojari is the co-founder and CEO of Cashinvoice. The opinions expressed are those of the author.

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