Analysis. Giving SMEs access to funding

The oft quoted line, that small and medium enterprises (SMEs) are the backbone of the Indian economy, is not mere rhetoric but is clearly supported by facts that highlight the sector’s contribution to the economy.

According to the Ministry of Micro, Small and Medium Enterprises, SMEs contribute around 9 per cent to India’s GDP, accounting for as much as 30 per cent of India’s total exports and 45 per cent of the country’s manufacturing output. The SME sector employs over 100 million people who are engaged in activities across industries.

From traditional handicrafts to manufacturing and services to high value-add sectors employing technology, SMEs are fuelling India’s growth engine. In August 2016, the Union Minister for Commerce, Nirmala Sitharaman, asked the RBI to cut interest rates by 2 per cent in order to boost the SME sector and help create jobs. This came in for a fair amount of criticism and debate but the underlying message was clear — allow the sector to grow and become a larger stakeholder in India’s growth.

Unfortunately, small and medium businesses in India are held back from becoming true global contributors. Lack of infrastructure, increased costs, reduced profitability, elongated working capital cycles, unavailability of skilled talent and bureaucratic hurdles plague them. When inadequate funding is added to this long list of issues, one really begins to appreciate the ordeals that these businesses are experiencing.

Another important factor that will mitigate most of the challenges and become a critical enabler is the advent of alternative lending models that are redefining how SMEs access credit. The year 2016 marks 25 years since economic reforms were initiated in India and this is as good a time as any to take a closer look at how a variety of funding models will lead to greater financial inclusion of SMEs.

There are 50 million SMEs in India and adequate working capital is the lifeline for all of them. However, a large majority of SMEs are unable to access credit from traditional banks and NBFCs due to cumbersome vetting processes, collateral requirements, inaccurate or incomplete credit scores, expensive lending rates, prolonged approval times and minimum business age requirements. The last five years have also seen the emergence of new-age digital organisations and technology-enabled businesses that are redefining the services space in the country.

Traditional banks don’t necessarily have an understanding of these sectors and therefore consider them high risk. This caution stems from already high NPA levels that they are contending with. This, in effect, has created an enormous financing gap that the International Finance Corporation (IFC) pegs at around ₹2.93 trillion. Alternative lending models, especially those employed by financial technology (FinTech) businesses, are beginning to plug the financing gap.

Every step, from application to disbursement, has been made easier and faster. Borrowers need only visit the lender’s website, fill up a form and submit it to complete the application process. While traditional banks use CIBIL scores and reams of paperwork to evaluate the eligibility of potential borrowers, digital lenders are betting on data analytics to go beyond credit scores to make lending decisions. Everything — from social media activity to online spending to mobile usage — is taken into consideration. Machine learning algorithms are able to complete the entire process in a matter of hours.

This has led to the creation of a larger database of credit-worthy companies, allowing lenders to expand their reach. Armed with this information, digital lenders are able to approve loans extremely quickly, sometimes in less than 48 hours.

Technology also ensures enhanced price transparency as well as letting borrowers know the real time status of their applications.

Disbursing short-term, collateral-free loans in a matter of days compared to the weeks and months it took in the past has significantly reduced working capital cycles, allowing SMEs to conduct their businesses proficiently. Alternative financing models are now forcing large banks and NBFCs to evaluate the use of technology in their lending process.

Many traditional banks have begun identifying branches that will be digitally enabled to expedite loan disbursement. While multiple steps have already been taken to ensure the longevity of SMEs, it is imperative that their financial inclusion is taken up on a war footing.

The writer is Co-Founder & CEO, Lendingkart Technologies Private Limited

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