MSME: Banks, NBFCs or maybe fintechs. Who is in a better position to plug the $240 billion credit gap for MSMEs? – The Economic Times

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SynopsisWith technology transforming the lending landscape, are traditional lenders losing sheen and who’s best placed to lend to SMEs?

For 65 million Indian MSMEs that contribute over 45% of the nation’s manufacturing output, a lack of timely and adequate access to funding remains their Achilles’ heel. A report by an IFC-Intellecap in 2019 on unmet credit gap had pegged it at around a massive $240 billion (about Rs 17.40 lakh crore).

Given the vulnerabilities faced by small businesses today, the MSME sector’s liquidity needs have witnessed a spike. As MSMEs scramble to raise funding, a pertinent question to look at is, which lending model appears to be best positioned to lend to small businesses? Because, while for some, traditional banks remain the preferred choice, for others knocking on the doors of NBFC players might be relatively more hassle-free.

The aforementioned IFC-Intellecap survey reveals that in the MSME ecosystem, the overall demand for both debt and equity finance by Indian MSMEs is about $1.4 trillion, which comprises $1.1 trillion of debt demand and $283 billion of equity demand. Of this total demand, a major part–84% is financed from informal sources. Formal sources cater to only 16% of the total MSME debt financing. Also, within the formal financial sector, scheduled commercial banks account for nearly 81% of debt supply to the MSME sector, states the report.

Certainly, the banking sector has so far been leading the pack in facilitating the credit supply to the MSME sector. So, are banks still the preferred lender for MSMEs?

Rajeev Yadav, MD & CEO, Fincare Small Finance Bank (FSB) believes so. He affirms that the banking sector remains at the forefront in serving the unserved and underserved, retail and MSME segments. “Banks have a deeper understanding of the target customer segments and their needs, access to technology and digital tools, stronger employer pull, cost structure and business models to reach the credit-hungry customer segments. With the advantage of a holistic framework, banks are best positioned to support the economic revival and inclusion of MSMEs,” reasons Yadav.

For many obvious reasons, traditional banking institutions have remained the go-to choice for MSMEs. Their strong linkage with the government is one key reason for playing a role in it. The TransUnion CIBIL-SIDBI’s MSME Pulse report (Feb 2021) also makes notes of this trend. The report states that PSB have lately taken the pole position MoM on MSME loan origination. With the launch of the ECLGS, loan originations surged in Jun’20, growing at 115% over Jun’19 and continued to be high and close to pre-Covid-19 levels for the rest of the year, it states. However, the report mentions that most originations are towards the existing to-bank (ETB) segment, and new-to-bank (NTB) originations are finding it hard to recover to pre-Covid level. Herein, lies the banking sector’s critical weakness.

Barring the ECLG scheme, the general sense in the industry circle is that tapping the new-to-credit segment remains a pain point for banks that largely play a cautionary role while lending to MSMEs.

According to Animesh Saxena, President, Federation of Indian Micro & Small and Medium Enterprises (FISME), banks are still hesitant to lend. He flags that even the RBI data shows that banks’ lending to MSME as a percentage of their total lending has consistently been coming down since 2000.

Private banks are ‘selective’ when lending to MSMEs.Blaming banks’ straight-jacketed criteria for approving eligible borrowers as the key reason banks are failing in tapping new-to-credit customers(NTC), Saxena highlights that rating agencies follow the same formula both for rating a large corporate and an MSME, which eventually hurts MSMEs’ applications.

“The rating system of the MSME should be different as MSMEs will never qualify to get a decent rating under the existing framework,” he says, adding banks’ limited reach remains one of their critical flaws.

The industry representative, however, also acknowledges that few private banks’ share in MSME lending has lately gone up, yet he maintains private banks are still very selective and their reach is very restricted, limited only to urban areas.

“Banks should mandatorily be asked to fix a certain percentage of their lending to MSMEs. If MSMEs contribute 40% of the nation’s industrial output, shouldn’t a similar percentage be fixed for lending by banks to them,” questions Saxena.

On the viewpoint held by many that banks are hesitant to lend, FSB’s Yadav maintains that currently, bankers are not averse to lend. However, they want to lend to the right customer segments as they have a fiduciary responsibility towards their depositors, and hence prudent credit norms and sound underwriting involving ground level checks drives lending processes.

Can the NBFCs be the saviour?
The NBFC segment has traditionally been a critical part of Indian financial ecosystem. Several reasons, compared to legacy banks, work in this segment’s favour. From relatively relaxed eligibility criteria to flexible interest rates, to a wider presence across the nation’s hinterlands, several factors make NBFCs the preferred choice for a large section of under-banked/unbanked MSMEs.

But the big question now is, can the NBFC sector shoulder the massive task of effectively addressing the MSME’s funding needs? The past trends don’t suggest so. Evidence from the IFC report shows that NBFCs and smaller banks, such as Regional Rural Banks and Urban Cooperative Banks, constitute only 19% of the normal MSME debt flow in India.

Recent trends also indicate that a growing level of stressed assets in the NBFC segment further dealt a body blow to this segment. The issue is so grave that a recent Crisil report stated that NBFC stressed assets may hit Rs 1.5-1.8 lakh crore by fiscal-end. The report states that “NBFCs have observed relatively the sharpest decline” in credit outstanding of their portfolios, making them lose market share in the MSME lending industry. Hence, it’s clear that the NBFC sector, on its own, currently cannot address the task in question.

RBI data shows that banks’ lending to MSME as a percentage of their total lending has consistently been coming down since 2000.Is technology the panacea?
As the Fintech trend continues to disrupt the finance lending segment, there certainly are clear win-wins for lenders and borrowers alike. Understanding customers’ urgent needs and offering a customised solution remains central in actualising right-fit models for borrowers.

According to Shachindra Nath, EC & MD, U GRO Capital, digitally enabled and nimble lenders who can move beyond the straight-jacketed approach of lending and build predictive cash flow models, through a deep understanding of the sector, early cash flow indicators in banking/GST etc., would come out as clear winners. Nath also highlights the correlation between fund reserves and being an effective lender. “The other often forgotten part of the puzzle is the liability side — lenders with a strong balance sheet and ability to raise liability capital in this market will cater to customer demands more effectively,” he adds.

Each lending model brings its own set of cost-benefits too. Alok Mittal, CEO & Founder of lending platform Indifi Technologies, believes that in the lending space — in its both traditional and digital formats — there is a mix of models, with different companies specializing in different areas. In his view, banks have been at the forefront in providing benefits under emergency credit lines because their cost of capital falls in line with the pricing expectations. “However, if you look at the resumption in new credit facilities to MSMEs, Fintech players have been further ahead in this space. And many digital lenders are working with banks to make that happen. So, while we may help perform the origination and credit analytics, banks back that up with their risk management processes and capital. There is enough rationale for partnering between the two models (banks plus Fintechs) to ensure that it can serve the end customer at the lowest overall cost,” Mittal opines.

No one size fits all
The MSME segment has traditionally been under-served by the formal credit sector. In the current pandemic times, informal financing channels have turned less forthcoming with credit to the MSMEs, thanks to their crippled finance cycle. This shrinking elbow room has aggravated the crisis for MSMEs. Yet, it’s also true that emerging financial trends have completely democratized lending and borrowing opportunities.

Robin Bhowmik, Chief Business Officer, Manipal Global Academy of BFSI, opines that tech-based models have the potential to serve a wider segment of the market with greater efficiency. “Today, the focus is on collaborative models which are mutually beneficial. For example, under the white label model, banks leverage the technical expertise of Fintech companies across the scope of lending – application processing, collections, etc., while they remain the customer-facing unit throughout,” he says.

A bulk of the lending for MSMEs still happen through the informal system.Echoing similar views, Amit Das, Founder & CEO of Think Analytics, says traditionally NBFCs have led the way in SME lending and it’s a segment that is seen as, “Slightly riskier, more difficult to underwrite, thick-file processing oriented.” However, as he sees it, lately Fintechs have also leveraged partnerships with traditional NBFCs to augment their lending capacity as well. “In the next 2-3 years, this space will see Fintechs take stronger positions with stiff competition from some banks. NBFCs will probably take a back seat and provide lending capital through structured partnerships. The joker in the pack, of course, will be the evolution of Neobanks, and their focus segments,” he asserts.

Besides legacy banks, Neobanks, which in simple words, refer to virtual banks, have also been gaining prominence. Notably, the country is home to over 15 Neobanks. Given their thrust on all-cloud based operations, the idea of Neobanks is quite compatible with post covid era too. Deena Jacob, Co-founder & CFO of Neobank platform Open, believes that lenders today have a huge opportunity to collaborate and create innovative products which are borrowers’ products in stark contrast to lenders’ products that traditionally was the case.

Given the vulnerabilities faced by Covid hit MSMEs, experts also believe the sector’s diverse yet fast growing capital requirements call for embracing newer lending models and shunning old ones. According to Vinod Parmar, Global Head-Sales and Marketing of a trade finance platform Vayana Network, the Covid hit MSME sector’s liquidity is currently low and there are no new assets to pledge. Thus, in his view, traditional collateral-backed lending models can’t help such businesses anymore. For such a segment, he believes cash flow based lending models to be the need of the hour. With growing digitization and availability of trade data, it is possible to assess and onboard MSMEs on templatised programs like supply chain finance, he says.

However, FISME’s Saxena also maintains that Fintechs have currently not been much of a help to the sector. Most Fintechs are only lending to “‘safe” businesses that have a digital financial footprint. “Fintechs penetration is still very limited among the traditionally run small businesses that form a sizeable chunk of the MSME segment. Fintechs do a lot of due diligence, and in fact, most times, their parameters are much higher than even those of banks,” he says.

It is still up in the air who can provide some succor to the MSME sector’s every funding issue. It’s also time borrowers shun their straight-jacketed view over lending avenues and models. Similarly, MSMEs need to invest in data and technology to borrow from tech-based lenders.

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