Unlocking MSME Lending: Is Digital Infra Ready?

The last decade in India saw unprecedented growth in unsecured consumer loan disbursals - as banks, fintechs and NBFCs all capitalised on the ease at which loan journeys could be digitalised. Enormous progress in underwriting infrastructure, digital KYC, digital signatures and even repayment mandate set-up made unsecured consumer loan disbursal easier than ever.?

However, we have seen a decrease in velocity over the last 2 years. This is coupled with some pretty strong signals of “speed breakers” from the regulator.? In November 2023, RBI significantly increased the required risk weights on unsecured loans and began more stringent monitoring of the space. This shift in the lending landscape has partly directed attention to alternative sectors like MSME lending.?

MSME lending has been a relatively under-tapped opportunity for a long time but with digital infrastructure now emerging - will this be the next most lucrative segment for lenders??

Before we deep dive into how effective the current digital guardrails for MSME lending are, let’s take a closer look at the opportunity.?

MSME Lending: The BIG Opportunity

Micro, Small, and Medium Enterprises (MSMEs) are the backbone of the Indian economy, contributing approximately 30% of the nation’s GDP, 36% of its manufacturing output, and 44% of total exports. And that's not all. Over 64 million MSMEs provide employment to 110 million people fuelling the country’s economy. For this reason, regulators and governments across the country are increasingly focusing on how we can make MSMEs more productive, grow faster and employ more people. Historically, one of the most crucial challenges they faced was in accessing formal credit. One SME expert I used to work with would say - “all an SME needs of access to Customers and Credit, the rest they can do by themselves”?

The sector, some estimates suggest, is burdened by a credit demand exceeding $500 Billion while only 11% of businesses can secure formal financing and hence rely on black market alternatives.?

Why is this? Why isn't the traditional financial services industry rushing to fill that credit gap? One of the main reasons is the relatively high operating costs of servicing this demand. And as in other parts of the world - this operating cost is starting to reduce as digital solutions come into play.?

The Dearth of (digital) Data Rails

One of the main reasons for this extra operating cost is the lack of adequate data infrastructure. Traditional lending relies heavily on financial statement analysis,? verification, income tax returns, and collateral assessment - much of which is conducted manually. And in the case of micro-enterprises, much of this data is simply not available. As well as lengthy loan processes, this often leads to the involvement of intermediaries who determine rates and negotiate terms, further complicating the process.?

Most micro and small enterprises require small ticket loans in the range of $600-$1200. This is not lucrative for lenders considering the costs involved. Using alternate and digital data sources of data and using technology to replace manual processes of verification and underwriting, can change the status quo here.?

And Yes, Things Are Changing…

The landscape of MSME financing is evolving fast, driven by data-driven approaches and digital innovations. It took off during COVID-19 when businesses, small and large alike were forced to move to digital processes. The advent of the JAM trinity (Jan Dhan Account, Aadhaar, and Mobile) and UPI have generated vast amounts of transactional data that would be a gold mine for underwriting. Data from platforms like the Government e-Marketplace (GeM), which is used by central and state governments to procure goods from small businesses, can offer a comprehensive view of borrowers' financial health in real time. This shift from traditional documentation to transactional data is paving the way for innovative lending models such as flow-based lending and invoice financing.

Goods and Services Tax (“GST”) collections recently surpassed $27 Bn in April. This itself is a reflection of the massive opportunity for invoice discounting/purchase finance as tax paid by a small business is a derivative of metrics such as turnover and revenue.?

Enter Open Credit Enablement Network (OCEN) & Open Network for Digital Commerce (ONDC)

The Open Credit Enablement Network (OCEN) represents a significant leap forward in MSME lending. OCEN integrates all ecosystem members—lenders, borrowers, and Loan Service Providers (LSPs)—on a single platform, facilitating seamless interactions and efficient credit processes at scale.?

Open Network for Digital Commerce (ONDC), an open protocol developed to promote greater access to digital commerce - is democratizing e-commerce for small businesses, it is also betting on financial services like personal loans & GST-based invoice loans by bringing all facilitators on their platform.?

With account aggregators, even real-time GST and banking data from multiple parameters are readily available. This can be modelled to create underwriting models to finance transaction-level loans . For example, an invoice raised by a toy factory, a GST-registered business on say a plastic factory can be financed using bureau + GST + Banking and the invoice data.?

By leveraging GST invoices, alternative data, and cash-flow analysis, OCEN & ONDC can unlock a $500 Billion opportunity in MSME lending. Both platforms simplify the lending process, making it more inclusive and accessible.

While early signs are positive, there are concerns with limited participation from banks limiting the true potential of the platform.

Enhancing Digital Guardrails

While the RBI has time and again stressed that AI-ML models need to be ‘robust and tested and re-tested periodically for underwriting’ and ‘adhere to data protection regulations’, there is still scope for these models to be used to enhance the lending process. Automating intermediary decisions like rate determination and negotiation, using Business Rule Engines (BREs) and dashboards for agent management will not only make the process faster but more reliable and scalable. It is here there is a need for a tech infrastructure to not only automate the loan process but also expedite it.?

Exciting times ahead

The transition from traditional lending models to innovative, data-driven approaches can democratize access to credit, empowering millions of MSMEs. While there is a lot of innovation happening, often government-led, the current landscape also underscores the need to build reliable lending-tech infrastructure that can integrate multiple layers of the process. Some of the systems banks use are still decades old making it tough to integrate into newer technology fintech and DPI solutions. It is here that we will see more action in the coming years.?

What do you think will further spur growth in MSME lending and what digital solutions can be game-changers? Tell us in the comments below.?

#FutureFinance #MSMElending #DigitalInfrastructure?