If India is to sustain its onward march of 7 percent-8 percent of annual economic growth, the 50-million strong Small and Medium Enterprises (SME) sector has a vital role to play. However, in their quest for growth, SMEs find working capital and timely access to it as serious concerns. A survey that covered over 500 SMEs across India found that ‘lack of easy finance and credit instruments’ was their most critical challenge. This survey by the Firstbiz and Greyhound Knowledge Group further found that seven out of 10 SMEs were facing major hurdles in accessing credit/capital when they needed it the most.
The findings of this survey make one wonder if our ‘financial inclusion policy’ really encapsulates the best interests of SMEs – a sector that contributes 45 percent of the total industrial output and employs 40 percent of the national workforce.
The term ‘financial inclusion’ traditionally referred to providing un-banked entities with banking products and providing tax breaks. Perhaps it is time we broaden our vision of financial inclusion by moving beyond enablement to true empowerment. To help SMEs succeed, we may have to empower them with access to and availability of financial products along their journey of growth, and not stop at mere provisions of accounts and subsidies.
Traditionally, SMEs have remained a financially unorganised sector. The operations and ownership of such businesses have remained confined to the family or a small group of associates. Moreover, SMEs are characterised by their use of cash payments for the procurement of raw materials and delivery of goods/services. This modus operandi has ensured little or no paper trail of transactions, thereby denying the SMEs a chance to explore financial products required for working capital or expansion. On the other hand, the lack of a paper or digital trail of transactions and appropriate documentation has discouraged mainstream banking institutions from offering them capital for scaling or for increasing their profitability.
In moments of dire necessity, it isn’t uncommon for SMEs to raise loans from financiers in the informal sector. These entities are known for charging high interest rates and questionable recovery practices.
Is there relief then, for these traditionally underserved segments? Let’s find out.
A sound financial inclusion policy must look beyond compliance and tax benefits. It should make working capital accessible and available to the vast majority of SMEs who are currently forced to raise capital from the informal sector. True empowerment comes from creating a level playing field between SMEs and enterprises. With easy access to capital, SMEs can adopt technology, utilise Information and Communication Tools (ICT), create IPs, and compete with enterprises.
Here are some means to democratise access to capital and help SMEs succeed.
Customized financial products
Categorizing urban and rural SMEs, or for that matter, a small kirana store with an IT startup, into the same bracket, results in providing cookie-cutter solutions to what are unique ecosystems. Imagine a professional entity that evaluates each SME’s requirement as unique and offers financial aid in the form of distinctly different products. Supply chain finance is, for instance, a popular and highly relevant form of financial aid for SMEs. Likewise, invoice financing can enter the picture in cases of delays in customer payments – a common concern for SMEs. Such accounts receivable financing can improve liquidity by turning the SMEs’ unpaid bills into cash and help balance the delays between spends and earnings. These products are hitherto relevant to specific SME segments and may not be universally applicable.
Credit line based on transactions trail
Let’s take the example of a self-employed person running a taxi or restaurant business. By encouraging these businesses to adopt digital payment modes, lending institutions can offer a flexible loan based on taxi usage and/or customer payments at the restaurant through POS machines. This is a win-win situation for banks as well as SMEs. These transactions also create usable digital data that can be underwritten by new-age lending companies to better understand the capital requirements of the SME.
Eliminate bias from assessment procedure
When it comes to securing a bank loan, the odds are stacked against the small-time entrepreneur. Lack of experience, absence of collateral, higher risk assessment, modest financials and small-ticket sizes are often quoted as reasons for the denial of capital. There is a strong need to evaluate each SME as a separate case and assess its credit-worthiness based on its unique credentials, instead of past performance and repayment history.
Often, timely access to credit, hassle-free paperwork and friendly attitude of the banker may matter more than cheap credit, particularly for fresh entrants. Erasing lender bias helps first-time applicants enter the system, thereby levelling the playing field.
Bridging the urban-rural divide
A majority of the SMEs reside in rural India. A national bank may have to don the role of a microfinance institution (MFI) to cater to the small-ticket loan requests and customized needs of the SMEs. Also, reaching out to the diverse and distributed set of SME customers across the country is not easy and often results in high unit economics for traditional financial institutions. Doing away with an elitist approach, or a branch-based one, opens up avenues for further financial inclusion. This is made possible by adopting technology and embracing the reach provided by the internet. New-age lenders leverage technology to widen their reach and service the financial needs of SMEs, which is particularly beneficial to borrowers in Tier 2 and Tier 3 cities.
Of the 50 million SMEs, only 2.5 million have been beneficiaries of the government schemes, about 3 million have websites and a mere one million of Indian SMEs export globally. While this situation may seem like a hurdle for the large banks, it presents a vast opportunity to the other players – Fintech lending companies.
Over the last few years, NBFCs have taken giant strides. A report titled ‘NBFC: The Changing Landscape’ put out by PwC and Assocham finds their contribution to the economy has grown from 8.4% in 2006 to over 14% in March, 2015. The report further suggests that mounting bad debt at public banks is likely to bring down their appetite to lend, especially in rural areas. This presents an opportunity for NBFC-based Fintech lenders to fill the gap, especially where traditional banks have been wary to serve.
The moment is ripe for smart and agile new-age Fintech lenders to collaborate with large banks in addressing the credit demand through reduced documentation, smarter assessment of risks and shorter disbursement cycles. This partnership could be the crucial missing piece in the financial inclusion vision, and could catalyse India’s aspiration to become a global knowledge, skill and manufacturing hub.
(The author is senior VP-Credit at Capital Float, a fintech company)
Updated Date: May 30, 2017 14:54 PM