MSME Lending: Finding the Right Segment

"Lending business isn't all about speed of disbursements, but of collections" with this thought in mind, we will try to figure out how "finding the right segment" is important.

Market Segmentation - Segmenting the market is simply breaking down the big market into smaller groups and create products & services catering to the needs and preferences of the small groups. From a business point of view, segmentation helps to identify the most profitable sub-groups and reduce inefficiencies.

SMEs & Access to Formal Credit

For a developing economy like India, SMEs plays a crucial role in generating employment and products for ever-increasing domestic consumption. Lots of initiatives were also taken by the incumbent government under the Make in India banner to help this segment but unfortunately, the demand for financing is outpacing the supply of finance.

Traditional lenders(mainstream banks, SIDBI, FCs) always ask for a plethora of documentation and securities, which typically these small SMEs have no idea about. As per an industry estimate, only 5-7% SMEs have formal access to credit and the rest of the segment is fully dependent on informal lenders. Two biggest factors contributing to the financial exclusion of this segment are - 1) Comprehensive Credit Score 2) Time consuming lengthy process.

The Age of Digital Lending

The "FinTech revolution" as we commonly call took shape in the form of advancements in the space of payments, lending, insurance and banking sectors. Four major factors which supported the growth of FinTechs are - 1. Focus on consumer behaviours, 2. Smartphone becoming a goto device for everyone, 3. Some relaxation on the part of the regulatory environment and finally 4. Lenders ready to change their business model to avoid any future disruption.

In June 2019, Lending Techs raised almost 600M$, topping the charts of FinTech VC/PE fundings worldwide. A clear indication of potential in this sector.

LendingTechs in India

The 4 factors played out well incase of India also. With improved digital infrastructure (India Stack) and centralized financial & tax data (GST), a new age of FinTech companies started coming into the picture to help in solving the biggest challenge of SME sector - access to formal credit. Overnight, lots of lending startups came into the picture with founders/VC fundings, but with no clear goals and identified segments. Founders, excited with the payments sector "winner takes it all" philosophy focussed only on growth, giving out loans to everyone resulting in huge losses. The winning pointer of "network-effect" in the payments (consumer) market is no longer valid in Lending space and business model here needs a clear definition. Lending business creates assets as well as NPAs. As with the revenues, losses may scale with lending without a clear goal or strategy.

Two fundamental ways to find your segment in SME Lending space are:

1. Identify the digital trail & lending demand - With the internet being part of many businesses it is easy to find the digital trail of all the transactions associated with the business. Moreover, GST data can be a good indicator of business performance and easily available with API integration. So clubbing the digital data (for traceability) and lending demand, we can get the clear idea of sectors/industries which can be well-targeted for any lending business.

As we can see from the figure above (Source - BCG), Telecommunications (operator data, usage data), food & board (data from Zomato, Swiggy etc), Tourism & hospitality (data from travel aggregators like yatra, cleartrip etc) can give wonderful data insights and traceability at the same time.

2. Sector-specific Score-cards - One size fit all is no longer valid in the SME lending business. As with the lending demand, different sectors have different credit risk-profiles. Quantifying such risk-profiles and assigning a score-card number can help the lender make a quick & more rational decision. The product offers and discounts can also be tailored to the sector-specific risk score making costs more transparent and reduce inefficiencies.

A sample framework from S&P Global clearly shows the risk profile estimation where the Industry Risk Score becomes one of the Macro factors for any lending decision. Similarly, different sectors will have different sort of group support & governmental supports which should be catered in while deciding riskiness of a sector.

Circling back to the point from where we started, lending business is all about collections and a clear segmented risk-profile can help in trouble-free collections.

Feel free to share any thoughts, opinions and ideas related to segmentation or lending.

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