How to make MSMEs credit ready through supply chain financing – The Economic Times

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Over 70% of the funds needed by small business is in the form of working capital. The current set of loan products offered to MSMEs by traditional FIs are limited in nature. MSMEs do not get access to short term unsecured loans easily.

The micro, small, medium enterprises play a crucial role in creating jobs for the industry but they struggle to get easy access to funds when needed. India has become a hotbed offintechwith over 2,100 startups in the sector. But have managed to reduce the cost of borrowing? Provided funds on-demand and in a frictionless manner or helped MSMEs manage their cashflows better?

This situation became worse during Covid and the stretched working capital led to the closure of many small businesses. The targeted approach resulted in banking services reaching the last mile in the form of bank mitras. During the pandemic, JAM (Jan Dhan-Aadhaar-Mobile) allowed the government to directly transfer funds in the accounts of economically weaker sections of the society.

A similarly focused approach is needed for building capacity across the MSME sector. The UK Sinha committee report has too made recommendations to that effect.

GEN (GST, e-Invoicing, NBFC-AA) is the new JAM (Jan-Dhan, Aadhaar, Mobile). Over 70% of the funds needed by small business is in the form of working capital. The current set of loan products offered to MSMEs by traditional FIs are limited in nature. MSMEs do not get access to short term unsecured loans easily. GST, e-invoice and NBFC (account aggregator) can be the enabler of cashflow based business loans.

  • GST data provides an effective tool to monitor borrower’s business on a near real-time basis which can provide a strong indication of impending default.
  • e-Invoice will provide an additional layer of trust and authenticity for financiers to identify and fund genuine trade transactions.
  • NBFC(AA) or Account Aggregators which have gone live recently, will give the financiers a single window, consented view, of the financial information across the participating entities giving another layer of comfort.

Coupled with PCR, the complete journey of origination, assessment, disbursal and collection will be completed digitally and seamlessly, thereby significantly reducing costs and friction.

Another step taken by the government to strengthen cash flow-based lending is by amending the Factoring Act, 2011. It will allow thousands of NBFCs to extend credit to the MSMEs based on their receivables. Combined with Trade Credit Insurance, funds could be extended to SMEs without them having from run pillar to post.

There’s still time for all the public digital infrastructure to go live, regulations to fall in place to provide the intended benefit to MSMEs. In the meantime, the risk of third wave must be mitigated.

Ways to alleviate the risks:

  • Credit is a liability – Any funds a business takes on credit is a liability and needs to be repaid.
  • Cautious with cashflows – Businesses need to be very cautious of their cashflows. For a couple of years, supply chain glitches are here to stay.
  • Inventory Management – Shortening production plans from quarterly to monthly. Reducing finished goods inventory to confirmed orders till normalcy returns.
  • A strong supply chain finance(SCF) program

Corporates and OEMs have understood that their future is dependent on multiple constituents. They need to support SMEs by offering multi-tier SCF programs that could be run in-house or managed by a third party. An effective SCF program will help mitigate the risk of unpredictable cash flows.

SCF gives comfort to financiers as the end use of the funds is determined and it is in the interest of both buyer and seller to honour their obligations. This allows MSME borrowers to access bank finance based on who they buy from or sell to, rather than the credit rating of the borrower itself.

Consequently, SCF allows MSMEs to access larger volumes of bank credit based on the strength and volume of their trade transactions. This credit is available at much lower rates than those availed basis 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 an uninterrupted flow of materials and services from their smallest suppliers to timely delivery of finished goods to their end customers.

In India, only 10% (6 – 10 million) MSMEs get access to formal sources of finance, this represents 40-50% of the value of credit extended to the sector. The rest of the MSMEs take loans from informal sources of finance at usurious rates. Formalisation would be the key and right set of incentives and support could lead many of the MSMEs to be eligible for formal credit.

SCF is a solution that would offer multiple benefits to the MSMEs and provide them with the required resilience to face another wave of the pandemic. It is important to educate MSMEs and their anchors regarding such alternatives to streamline cashflows. Many of these micro enterprises need to move to the next level and become big.

(The writer is founder & CEO of Vayana Network)

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