Lenders’ reluctance to extend financing to most MSMEs can be traced back to their inability to adequately assess creditworthiness of small borrowers and monitor their performance based on data made available to them.
As the second wave of Covid 19 pandemic continues its march across the country, businesses both big and small are beginning to experience disruptions to their operations as local governments impose restrictions on movement of people and goods across the country. Supply disruptions followed by overall demand slowdown will impact businesses and livelihoods across the board. Unfortunately, the highest economic costs of these disruptions will be disproportionately borne by the MSME sector in India.
It doesn’t take much to understand the vulnerability of the MSME segment to economic cycles. On the one hand, India boasts of over 62 million MSMEs which contribute to nearly 30% of the country’s GDP and create employment for over 110 million people, on the other, a vast majority of them are starved of low cost financing from the formal banking system. Instead, they are forced to rely on informal lenders for managing their financing needs often at usurious costs. The direct consequence of this credit gap for MSMEs is a vicious cycle of high costs, low profitability, stunted growth and inability to withstand even mild economic shocks.
For the fortunate few who do have access to the banking system, an economic disruption brought about by the likes of the Covid pandemic brings in its wake an almost immediate tightening of credit terms from lenders. Ironically, it is when the MSME is most vulnerable and needs a higher dose of liquidity that lenders choose to turn off the credit tap. This follows from a heightened risk perception of the MSME segment as a whole, which forces lenders to take evasive action. It doesn’t help that large creditors too tend to squeeze MSMEs by delaying payments, thus exacerbating their problems even further.
So, what financing solutions can alleviate the woes of the MSME segment, especially at difficult times such as these?
Understanding Supply Chain Financing
Lenders’ reluctance to extend financing to most MSMEs can be traced back to their inability to adequately assess creditworthiness of small borrowers and monitor their performance based on data made available to them. This is a consequence of unavailability of regular flow of credible financial and business data pertaining to such borrowers. Dated and unaudited financial statements, inconsistent business data provided by MSMEs hardly inspire confidence in lenders. This has compelled lenders to seek collateral security as a precondition to extending credit to such borrowers, which naturally limits the number of MSMEs who qualify for credit and the also the quantum of credit available to them.
Here the supply chain financing (SCF) could play a key role in bridging the trust gap by providing lenders additional tools to manage credit risk and expand the scope of financing to include large pools of poorly understood MSMEs. SCF offers technology based risk mitigation techniques to help lower financing costs and improve business efficiency of buyers and sellers in a trade transaction.
While SCF is manifested in many forms like discounting of receivables, payable financing, distributor financing etc, at its very core, SCF is the process of isolating credit risk associated with a trade transaction and financing the underlying trade.
This process allows MSME borrowers to access bank finance based on who they buy from or sell to, rather than the risk rating of the borrower itself. Lenders draw comfort from the fact that end use of funds is clearly known in SCF, as each loan disbursal always finances an underlying trade transaction.
How SCF helps
SCF allows MSMEs to access larger volumes of bank credit based on the strength and volume of their actual trade transactions, at rates which are significantly lower than they would attract on the strength of their standalone business and finances. Corporates in turn benefit from SCF as larger proportions of their supply chain gain access to cheaper and reliable sources of liquidity. This ensures uninterrupted and predictable flow of materials and services from their smallest suppliers, to timely delivery of finished goods to their end customers.
While SCF has been around for decades, its use has been limited to larger MSMEs owing to lenders’ high costs of origination, limited credit appetite and high transaction costs. However, with recent technological advances sharply bringing down cost of operations, and availability of newer and far more credible pools of real time data like GST, digital footprints, banks statements etc, SCF is increasingly being seen as a panacea for MSMEs and lenders alike.
Specialised platforms like Trade Receivable Discounting System (TReDS) offer MSMEs the ability to instantaneously secure highly subsidised credit from a range of Banks and NBFCs. Further, new age fintechs are redefining the rules of lending by using alternate transactional data to efficiently originate, assess and monitor borrowers, thus bridging the trust deficit between MSMEs and lenders. Digitisation of entire processes by SCF platforms which include invoice acceptance, e-signing of documents etc have served to dramatically bring down the cost of SCF, especially for small value transactions.
Adding to this heady mix of innovations are exciting digital user interfaces and customer engagement tools which are encouraging MSMEs who were hitherto hesitant to adapt to the digital world, to transform themselves and partake in what promises to be a brighter future.
As Winston Churchill had remarked ‘Never waste a good crisis’. The Covid pandemic may have hurt the MSME sector more than others, but this has triggered a response from all interested parties i.e lenders, MSME borrowers, service providers, fintech platforms to think harder, collectively and with a sense of urgency to roll out solutions to solve the problem of access of capital for MSMEs.
In conclusion, SCF is one of the proverbial vaccines for MSMEs. It has been tested extensively, is a brainchild of the latest technology and most importantly, provides vulnerable MSMEs a layer of financial protection to sustain them through a crisis.
Let’s collectively help each MSME gain access to SCF to see them through this pandemic.
(The writer is CEO & Founder, Vayana Network)(Disclaimer: The opinions expressed in this column are that of the writer. The facts and opinions expressed here do not reflect the views of www.economictimes.com.)Watch ETRise Top MSMEs Ranking Digital Felicitation Ceremony. Visit