The 6.33 crore of micro, small and medium enterprises (MSMEs) that are spread across the Indian landscape is the real engine that can propel the economy ahead of any other economy in the world. Our consumption and production capacities are unmatched provided we receive the right credit impulse from the banking ecosystem. However, small MSMEs do not have the necessary collateral to overcome the obstacles placed in formal banking channels.
This bottleneck is removed by an ingenious combination of two market players, namely banks and fintechs. The co-loan method is a unique proposition which is a win-win situation for all involved. Banks benefit from greater exposure to customers while FinTechs benefit from easy access to credit. The underwriting ratio is divided according to the 80:20 ratio with higher risk going to banks.
Meanwhile, it is the borrower who is really the winner in this whole transaction. Not only does a reliable customer get credit at competitive rates, they also have the opportunity to differentiate themselves from other players by building a solid credit history. The entire ecosystem benefits as more data is accumulated on different borrowers, which will pave the way for better loan disbursement hygiene in the future.
While this dynamic is still in its infancy, there are many other ploys that can be adopted by an entrepreneur to ensure their business continues to grow.
As the multiple options available show, the business scenario is far from catastrophic. Let’s dive into some financial tools that MSMEs can tap to accelerate their business growth.
Exploit central government programs
Fortunately, the government is keenly aware of the disappointing prospects for MSME finance and is working to clear the way to allow more fluid and transparent access to finance for MSMEs. He listens to the field and can understand the obstacles that stand in the way of linear growth for the businessman operating at the bottom of the pyramid. To alleviate the misery of MSMEs, the central government has instituted a number of loan programs.
However, MSMEs now need to show determination and initiative to scale up and boost their activity using loans that are distributed by the government. This is where the proactivity and resourcefulness of an entrepreneur comes into play. Information on government business loans has been widely disseminated, however, only a privileged few have really benefited while others. have chosen to stay away at their own expense. This is regrettable and can only be resolved if the larger MSMEs operating at the local level encourage other smaller MSMEs in their neighborhood to take out the loans offered by the government.
Here are the loans that individuals can benefit from:
- Ready for MSMEs in 59 minutes by SIDBI: As part of this initiative, MSMEs receive approvals for their loans up to Rs 10 crore within 59 minutes. The loan is paid to them within 8 to 10 days.
- Mudra loan programs for MSMEs: Loans from the Micro-Unit Development and Refinancing Agency or MUDRA are intended for unincorporated micro-enterprises. Initiated in 2015, loans worth INR 40,000 crore were disbursed until August 2020.
- Credit guarantee fund system for micro and small enterprises: Launched by SIDBI and the Ministry of MSMEs, units can benefit from loans of up to INR 20 lakh under the program. For loans over INR 10 lakh and up to INR 1 crore, collateral in the form of land or building associated with the business can be provided.
- National Small Industries Corporation Loans: NSIC has worked with several private and government banks to provide quick and special loans to micro and small units.
Working capital management
A major hurdle that many MSMEs face when dealing with multinational or blue-chip companies is their long payment cycle. As a result, MSMEs have no choice but to wait for their payments to come back to them even as valuable business slips away from them due to a lack of working capital. Meanwhile, these liquidity problems continue to hamper MSMEs’ expansion capacities and they are forced to limit themselves to a cycle of low income.
This is where fintech companies came in late. They provide additional liquidity to the MSME on the basis of its claims. It works wonders for small MSMEs as well as FinTech companies. The fintech company obtains payment insurance because it holds the receivables on behalf of the large company’s MSME. Meanwhile, the MSME can borrow on a receivables basis and continue to take more orders from other clients while generating more income and expanding its business.
This process only involves documentation first when the MSME is integrated. Subsequently, as the cycles of borrowing and repayment are repeated, a factor of trust and loyalty develops between the two actors cementing their relationship.
Work with businesses that lend on cash flow based lending models
Banks and other credit institutions have long been on the defensive when it comes to lending to MSMEs. A number of obstacles stand in the way of smooth credit disbursement, as bankers fear that the MSME account may default on payment. However, several new age fintech companies have emerged in the Indian scene that lend on the basis of corporate cash flow.
These companies look at the strength of the balance sheet, income statement, tax returns, and the credit bureau’s historical assessment to determine whether a company is creditworthy or not. In addition, working capital loans to help increase liquidity in business operations are also disbursed by these companies on the basis of anticipated cash flows.
Factoring is a financing process whereby a company sells or assigns its receivables to a finance company, i.e. a factor. The company cedes the receivables at a discount and instead receives a working capital loan to keep its business operations running smoothly.
Factoring has been a godsend in helping SMEs obtain liquidity. Large-scale customers often go on a deferred payment cycle that disrupts the working capital cycle of small businesses. A study of 5,000 MSMEs carried out by a credit rating agency found that SMEs can increase their profits by 15% provided they receive timely payment from large companies. With time-limited payments going to SMEs, their interest costs – according to the rating agency – will drop while collective profitability will increase dramatically.
Account aggregation framework
Until very recently, MSME borrowing data existed in silos. Data from one bank was not accessible to another and vice versa. This led to opacity in the data on the borrower and triggered a number of bad credit disbursement decisions. However, this situation is being corrected under the leadership of the Reserve Bank of India (RBI) as well as other regulators.
An account aggregator is an RBI supervised entity that brings together data from various MSMEs under one virtual roof. Lenders who register with a pool of account aggregators in their data under appropriate confidentiality standards and MSMEs have the right to determine whether their data should be disclosed or not.
Whenever a lender, for example a bank of a financial institution wants to disburse a loan, it searches the aggregated data to assess whether the borrower is in the database and what their credit history has been. The better the credit history, the higher the credibility of MSMEs.
Banks also feel more encouraged to lend after assessing a borrower’s payment history. Their credit disbursement decisions are supported by data and go beyond a monochromatic reading of the company’s financial statements.
MSMEs who have enlisted with an account aggregator have been inundated with cash and are encouraged to work in a transparent and accountable manner, as their credit management behavior today dictates whether they will have access to credit tomorrow or no. Irresponsibility and mismanagement naturally increase the cost of credit. Currently, all banks follow internal rules and guidelines on benchmarking the cost of credit based on the borrower’s track record and track record.