Today, India is home to the world’s biggest micro, small and medium enterprises (MSMEs) community (more than 60 million) who contribute around 29.7 per cent of the country’s GDP. Of these, 40 million have registered themselves on the Udyam Registration Portal of the Union Ministry of MSME. Despite being the vital cogs of the economy, MSMEs often struggle to access working capital and affordable financing necessary for their growth and sustainability. “Most of them lacks collateral, have lower credit ratings and financial instability. This makes access to formal credit difficult. Even if these MSMEs secure a loan, the interest rates would be high because of unsecured lending,” observes Sundeep Mohindru, Promoter & Director, M1xchange.

Low credit worthiness is a major stumbling block to secure loans. “This stems from the fact that they do not have economic size to operate and often their models are not scalable. Further, they are slow in becoming professional and their accounts are not fully in order to convince the lenders. SMEs, which have transcended these challenges, have no problems in getting finance or even taking the benefits from the government. While credit availability is still there, the cost tends to be high. Fintechs are offering smaller loans to these enterprises, though the interest costs tend to be very high to cover for risk,” observes Madan Sabnavis, Chief Economist, Bank of Baroda.

Accessing working capital often times poses a challenge for MSMEs, who represent a high-risk sector for the bank as they typically have a low credit rating. “Banks are skeptical about the loan repayment capabilities of MSMEs, so they apply stricter regulations to small businesses. The process of availing MSME loans involves complex documentation, requirement of collateral, strict repayment terms, and high-interest rates. Such requirements make it difficult for small businesses to secure MSME loans,” says Sachin Agrawal, Co-founder & CEO, Bizongo.

In the recent years, the government has introduced several schemes like Mudra Yojana, Credit Guarantee Trust Fund for Micro & Small Enterprises (CGTMSE), Fund of Funds, etc. In spite of this, MSMEs still face problems while raising working capital. “Traditional banking and financial institutions are generally reluctant to work with MSMEs because of small-ticket size loans and the limited ability of the MSMEs to provide collateral and relevant credit histories. Access to timely MSME funding, complex regulatory procedures, and insufficient financial knowledge are some of the daunting obstacles faced by MSMEs in India. This makes securing loans difficult, hindering SME expansion, and impacting the overall economy's growth,” says Agrawal.

Pain points for SMEs
While lending to SMEs normally banks tend to take 100-150 per cent collateral on their loans. CGTMSE and other funds of a similar nature in India try to incentivise these banks by covering a large portion of their risk (up to 85 per cent) and promoting a collateral-free lending process to MSMEs. “As good as this may sound in theory from a bird’s eye view, the practicality of this scenario may not sit well with banks as imagined. This is because these guarantee funds, although cover a large portion of their risk, are never 100 per cent. While banks are used to collecting 150 per cent collateral, this negates their incentive to lend with a perceived risk in the first place. In this case, the banks may only rely on the CGTMSE type funds when they would want to lend to someone who is financially sound rather than help those at the bottom of the pyramid who lack significant collateral to get a loan, defying the whole purpose of the fund’s existence,” observes Raja Debnath, Managing Director, Veefin Solutions Ltd.

SMEs require collateral-free loans as most of their books aren’t in order, or at least not as per the bank’s guidelines for financial institutions to verify. “The non-GST business maybe a large part of their operations which is not accounted for while assessing credit worthiness of an SME. Apart from this, heavy manual processes, physical document verifications and lack of technology intervention, leading to a significantly high turnaround time,” says Debnath.

According to him, a good solution to this is a well-designed credit guarantee system that provides a 100 per cent guarantee on loans given out to SMEs. “But, the credit guarantee fund will have to ensure that lenders do not misuse this and forego their underwriting process leading to a barrage of NPAs as a result. Therefore, the credit guarantee system needs to be designed in such a way where there checks and balances put in place to ensure the optimal use of the fund,” he elaborates.

TreDS in trend
One probable solution for meeting the financial requirements of MSMEs could be the introduction of newer models. Here, fintech can play a crucial role. “By expanding financial accessibility and offering specialised finance services, fintechs can facilitate the growth of MSMEs and also propel the industry towards enhanced efficiency, competitiveness, and digital inclusivity in the long run,” opines Mohindru.

According to Agrawal, supply chain finance or purchase invoice discounting can be one solution to this problem, wherein banks/NBFCs or other financial institutions (FIs) discount the invoices and pay MSMEs within the stipulated timelines. “Another solution is factoring, where FIs usually pay up to 80-90 per cent of the invoice value upfront. This facility can be very relevant for MSMEs that usually have huge outstanding invoices from large enterprises,” he adds.

MSMEs often face a major challenge in terms of delayed payments from their buyers, who are mostly large corporates, central public sector enterprises, and government departments. This severely affects the working capital of MSMEs. To address this, the Reserve Bank of India (RBI) introduced the Trade Receivables electronic Discounting System (TReDS), which allows MSME suppliers to receive immediate working capital on their invoices from multiple financiers, such as banks and NBFCs (non-banking financial companies), who bid on the bills at discounted rates. “The ease with which the seller and buyer can source working capital finance on TReDS by way of digital bill discounting is enabling faster growth. On TReDS, MSMEs get an access to much required working capital without collateral, and therefore there are no limitations to scaling up. As such, the interest rates related to TReDS are between 7 and 11 per cent per annum, whereas unsecured borrowing ranges from 16 to 24 per cent per annum. Therefore, MSMEs understand that this is a beneficial platform for them as they have access to working capital within 24 hrs and at lowest interest rates,” opines Mohindru.

Sabnavis observes, by adopting technology, MSMEs will be able to not just scale up their business in terms of procurement and sales, but also have access to finance from new sources of funding. “The TREDS platform is a good example of how SMEs can use technology to seek funds. Factoring is a very important part of the financial eco-system for the SMEs as this helps them to keep going even while the payments come in with a lag,” he adds.

Some of the other non-conventional ways for SMEs to obtain financing is through supply chain financing. “In the case for most SMEs, they tend to mostly require working capital in 2 major scenarios, either they have sold something and are waiting to get their dues, or they have a high value order for which they require working capital to process the incoming demand. Supply chain financing is the safest and quickest way for SMEs to obtain financing today because the invoice or the purchase order is backed by a large corporate with an intent to pay/receive funds for the transaction,” says Debnath.

Technology revolutionising lending ecosystem
With MSMEs looking to adopt automation/digital solutions, they are looking at the best options to raise finance for their modernisation plan. Mohindru believes that MSMEs have several viable financing options for their modernisation plans. “Traditional bank loans and credit lines are commonly used, often tailored specifically for technology upgrades. Furthermore, governments provide a range of programs and subsidies intended to assist MSMEs in undergoing a digital transformation, which makes them an attractive choice for securing necessary funds,” he states.

Beyond traditional financing, MSMEs can explore more innovative options through fintech that provide quick and adaptable funding solutions tailored to their specific needs, leveraging technology to streamline the lending process. “These diverse financing avenues enable MSMEs to access the capital required for adopting automation and digital solutions effectively,” says Mohindru.

With the adoption of digital solutions, SMEs can achieve greater output, faster production, and eventually increased sales. To keep up with this pace, these businesses require adequate working capital, which can be facilitated through quicker financing of their existing invoices. “By leveraging digital-first embedded financing platforms, both buyers and suppliers can access a wide pool of financial institutions (FIs) to find the best financing options tailored to their profiles. These platforms also enable SMEs to quickly create a 100 per cent digital loan application and select the most favorable terms without the need for physical visits to FIs, thus saving them crucial time,” says Agrawal.

Utilising these digital platforms, SMEs can build a transparent record of their financial transactions and repayments. “This documented history enhances their creditworthiness, aiding in securing future financing. The platforms' technology enables SMEs to efficiently manage their financial activities and access additional financing lines as needed,” opines Agrawal.

Technology has the potential to revamp the MSME lending landscape. This is where fintechs have stepped in to transform the lending space by leveraging new age technologies. Mohindru says, “By harnessing vast amounts of data, including transactional histories, payment patterns, and market trends, fintech platforms can develop comprehensive borrower profiles. Based on the detailed profiles and data insights, they can identify their financial health, risk propensity, and repayment capacity, thereby enabling more accurate credit assessments. For instance, data analytics tools such as credit analytics engine are reshaping credit evaluation methods, paving the way for a more inclusive and efficient financial ecosystem.”

Private banks eyeing for bigger role, but PSBs…
In the recent years, private banks have increased their focus on the MSME financing space due to its high growth potential and profitability. Mohindru observes, “They are leveraging digital transformation, improved risk assessment models, and tailored financial products to efficiently serve this sector. Regulatory support and government initiatives also make MSME financing more attractive. Therefore, banks and NBFCs are getting more confident about extending financial support to MSMEs. With the option of supply chain financing, banks are receiving a lot of requests from corporates for financing, which broadens their MSME lending portfolio.”

While private banks face challenges such as credit risk and higher operational costs, their aggressive strategies are driven by the need to diversify portfolios and capture a larger market share, thereby enhancing overall profitability and competitiveness. “Private banks hold a 43 percent share of MSME credit demand. In its latest report on the performance of the banking sector during 2022-23 and 2023-24 so far, the central bank noted that the co-lending framework for priority sector lending facilitated the flow of credit by NBFCs to the MSME sector, leveraging on the low cost of funds of banks and the greater reach of NBFCs. Large private sector banks are increasingly opening to working with fintechs to tap into the underserved unsecured business credit market,” says Mohindru.

The recent regulatory diktat to increase risk weightage ratio on unsecured consumer lending by 25 percentage points is pushing lenders to look for partnerships with fintechs in MSME lending. “Industry data shows that delinquency rates have fallen between 60, 110 to 220 basis points, respectively, for micro, small and medium enterprises between the fourth quarter of 2020 and that of 2023,” adds Mohindru.

According to Debnath, private banks have shown consistently higher growth rates in providing loans to MSMEs than their public sector counterparts. By investing in digital platforms to enhance their services and meet the specific needs of the sector, these banks are streamlining the loan application process, making it faster and more efficient for the rapidly growing businesses in the country. Private banks are also extensively looking to partner with multiple fintechs to increase their lending portfolio within SMEs in the country. With the support of technology and the India stack, private banks are now evaluating creditworthiness more accurately within seconds while eliminating most of the manual verification processes initially that were extremely time-consuming, enabling them to take a more aggressive role in supporting the growth of India's vibrant MSMEs,” opines Debnath.

Though private banks have shown their strong intend to grow in the MSME space, PSBs are expected to be the leading lenders for MSMEs. “Private sector banks are looking at this space with attention. But, it would mainly be the PSBs which will take on the role of empowering SMEs given that these are small tickets, which may not make economic sense to the private banks. As they perform a national duty, when it comes to priority sector lending, PSBs would be the drivers in the future,” opines Sabnavis.

Madan Sabnavis, Chief Economist, Bank of Baroda

Private banks are looking at the MSME space with attention. But public sector banks would be the drivers in the future as they perform a national duty when it comes to priority sector lending.

Sundeep Mohindru, Promoter & Director, M1xchange

The ease with which the seller and buyer can source working capital finance on TReDS by way of digital bill discounting is enabling faster growth. On TReDS, MSMEs get an access to much required working capital without collateral.

Sachin Agrawal, Co-founder & CEO, Bizongo

By leveraging digital-first embedded financing platforms, both buyers and suppliers can access a wide pool of financial institutions to find the best financing options tailored to their profiles.

Raja Debnath, MD, Veefin Solutions Ltd

Supply chain financing is the safest and quickest way for SMEs to obtain financing today because the invoice is backed by a large corporate with an intent to pay/receive funds for the transaction.