Digital Lending Can Propel Indian MSMEs to Global Leadership

By IT Advisory, 3EA
Digital Lending Can Propel Indian MSMEs to Global Leadership

MSMEs have emerged as a highly dynamic and vibrant sector forming the backbone of Indian economy. India's MSME base is the second largest in world only after China. As per official estimates there are more than 63 million MSMEs providing employment to around 120 million people and contribute almost 45% of the overall exports from India. Development of MSMEs is crucial for socio-economic transformation through generation of employment opportunities for urban and rural youth alike. This requires evolution of an ecosystem for businesses raring to compete in domestic as well as international markets.

While these enterprises drive economic growth with their ability to innovate and employ in large numbers, the biggest challenge faced by them is access to finance. Although contributing around 6.11% of the manufacturing GDP and 24.63% of the GDP from service activities as well as 33.4% of India's manufacturing output, they significantly lag behind China and the United States in terms of GDP contribution. Lack of formal sources of credit has been one of the major reasons for this. It has been estimated that more than 50 percent MSMEs meet their financial requirements through informal sources and end up paying higher interest rates on their borrowings, adversely affecting their profitability.

MSMEs in India struggle with the traditional challenges of banking. The chart below highlights the major pain points in the processing of MSME loans.


Easy availability of credit at lower rates through digital lending can trigger a virtuous cycle of formalization amongst MSMEs. Enabling regulatory environment followed by launch of Unified Payment Interface (UPI) and reduction in the cost and availability of mobile application based data have increased MSME connectivity and opened avenues for end-to end digital services to MSMEs including lending, with processing time reduced to as little as one day.

Digital lending can enable financial institutions improve productivity by processing more loan applications and increasing revenue per loan by providing cheaper, quicker and automated services. Studies suggest that digital lending to MSMEs currently accounts for only 5 per cent of the total lending to the sector but has the potential to grow up to 21 per cent over the next five years. However, this growth shall be driven by the extent of MSME digitization and their readiness for digital lending as well as an ecosystem that will facilitate access and sharing of data.

With introduction of the Goods and Services Tax (GST), the government set up a Special Purpose Vehicle (SPV) called the GST Network (GSTN) to create and manage IT solutions related to it and to provide common and shared IT infrastructure and services to the Central and State Governments, Tax Payers and other stakeholders for implementation of the Goods & Services Tax (GST). This shall not only serve to provide analytics and business intelligence to tax authorities but will also facilitate implementation and standardization of services to a tax payer and help maintenance of an interface between the tax payer and the tax administrative systems.

Delayed payments adversely affect the recycling of funds as well as the cost of operations of MSMEs, thereby leading to shortage of working capital and liquidity and even in bankruptcy or shutdown. To address this, the government set up Trade Receivables Electronic Discounting (TReDS), an electronic platform wherein MSMEs can auction their trade receivables, thereby facilitating lending to MSMEs. It is mandatory for all MSMEs with turnover of more than 500 crores to be on TReDS to enable entrepreneurs access credit from banks, based on their upcoming receivables, thereby solving the problem of cash cycle. To ensure smooth sanctioning of loans to MSMEs, the Union Finance Minister in his 2018-19 budget speech has suggested the potential linking of GSTN and TReDS.

When any MSME applies for a loan online along with a consent to extract data from different sources be it tax authorities, credit rating agencies or marketplaces etc., this data is collated to arrive at a composite risk score which is then passed on to financial institutions/lending agencies who are registered on that platform, based on their assessment and risk models these agencies in turn approach the MSMEs with their offerings and the MSME has the option to choose the lender on the basis of it requirement.

Several business models are expected to emerge over time. However, it is essential to realize that one size does not fit all. Different strategies/models have to be evolved for different types of MSMEs based on their specific requirements. This can be made possible through abundant data available.

The Indian market is growing rapidly and our entrepreneurs are making remarkable progress across diverse sectors, MSMEs are now exposed to greater opportunities than ever for expansion and diversification across sectors. The opportunity provided by digital lending will not only benefit the MSMEs but would also be a game changer in the traditional lending market.

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Article by: IT Advisory, 3EA
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