What is the “MSME Finance Gap?”
Did you know that MSMEs (Micro, Small, and Medium Enterprises) are the largest contributors to economic growth, gross domestic production, employment opportunities, and innovation in the country? In 2018, India’s SMEs contributed 37% of its non-agricultural GDP and employed 40% of its workforce.
Sadly, these MSMEs are crippled by many challenges, one of which is how to bridge the MSME financing gap, or the lack of easy access to finance. The importance of this sector for the economy has not been commensurate with the available formal financing, despite their heterogeneous organizational forms and offerings.
However, we can’t afford to ignore the MSMEs that are the backbone of our economy. A key strategy for advancing economic development and reducing poverty is to provide opportunities for MSMEs in emerging markets.
Whose Responsibility is it to Bridge the MSME Finance Gap?
The big private sector players like financiers and governors are responsible for supporting MSME development by targeting areas with high growth potential. Besides, understanding the extent and nature of the financial gap will help the public and private sectors better address this matter.
We may ask, “Why not banks?” It is undeniable that banks have historically supported MSMEs with regular loans. However, the global financial crisis has disabled the banks’ ability to take risks with funding SMEs, making them more cautious and conservative with SME lending. These financial institutions have imposed more stringent lending standards and tightened their requirements for funding approvals.
Banks are especially wary about lending money to businesses:
- Without a strong credit history.
- With a revenue of less than $2 million.
But that’s not all. Generally speaking, banks view SME loans as high-risk propositions, and they view SMEs as a challenging customer segment. On top of that, many banks are still plagued with manual, time-consuming, paper-intensive processes where the absence of systematized loan origination, even the maintenance of Excel sheets, could result in data loss.
On the SME side, things are worse. First, their search for loans does not end with one or two banks. They need to approach multiple banks before they are even considered for loans. Moreover, it takes them an entire day to complete the paperwork, and then they must wait months for their loan to be approved.
Since the constraints on SME financing are real, banks are not to blame. But we are left with the question: “Who is going to bell the cat?” Who will bridge the financial gap plaguing SMEs?
Also Read: Impact of Government Regulations on Business
Fintechs: A Saviour for Finance-seeking SMEs
The convergence of Fintech with formalization can provide for a million MSME borrowers every year. Studies show that with fintech funding, we could witness a 10-to-15-fold increase in disbursements to this sector through 2023. But how? How will fintechs bridge the financial gap and give MSMEs a new lease of life they desperately need and deserve?
Factors That Allow Fintechs to Serve the MSME Sector
Digitization in the form of smartphones and affordable data rates is one of the primary game changers in filling the MSME credit chasm. Digital financial services are becoming more accessible for MSMEs in emerging countries as mobile phones are increasingly used. Moreover, advanced data analytics and digital financial products enable these largely informal companies to establish a credit history, opening doors to formal financing.
MSME finance is becoming increasingly digital, and the alternative data it can supply offers both an opportunity and a solution for the credit gap, which is nothing short of a yawning chasm, especially in India.
2. Partnership with Banks
Maybe the banks aren’t lending money to MSMEs for a reason, but that’s not stopping them from partnering with fintechs to create convenient ways to better serve their MSME customers. If banks learn to integrate FinTechs into ongoing operations, they can vastly improve the customer experience at lower capital expenditures. Aside from the improved access to banks’ extensive customer bases, existing infrastructure, and lower capital costs, fintechs also benefit from the bank’s vast customer base and existing infrastructure.
3. Advances in technology
We are not far away from when intelligent automation, artificial intelligence, and machine learning will become mandatory for banks to remain competitive. In fact, banks are already in the process of reinventing SME loan processing by leveraging these advanced technologies. We can also expect banks to adopt other technologies like data analytics to effectively address the existing credit gap for SMEs.
The availability of a comprehensive credit assessment tool would also make it easier to verify documents during due diligence. As a result of the due diligence report, small-business owners can obtain customised loan packages tailored to their specific needs. There are several areas where automation could be applied, such as:
- Document capturing
- Document management
- Error-free data entry
- Reduction of onboarding time
- Management of collaterals
- Loan origination and approvalPersonalized services
- Auto-KYC verification
In addition to traditional lenders, analytic and processing capabilities will benefit banks, which will be able to provide data-driven insights for portfolio management and initial decisions.
Without a doubt, the digital transformation of MSMEs is certainly lowering transaction costs for the lenders and banks that also serve them. This digital advantage will help MSMEs create a larger digital footprint, making them an attractive alternative to SME lenders who thrive on data to lower loan origination and collection costs.
Let’s next explore the digital technologies aiding fintechs to lend loans to MSMEs.
2 Key Tech Trends Impacting MSME lending
Blockchain is proving to be one of the biggest tech blessings for fintech funding MSMEs. The main reason is that blockchain allows MSMEs to optimize from the extensive database of banks, traders, logistics companies, etc, for their benefit. Moreover, with easy access to open APIs, MSMEs can have better communication with fintechs and other lending institutions, who can, in turn, use their data to offer customised services and products.
2. Digitization of finances.
SME lenders and SMEs have a lot to gain from digitising SMEs’ finances. By leveraging its possibilities, digitization offers the opportunity to help at least 250 million SMEs, which currently have unmet or unfulfilled credit needs worth trillions of dollars.
What happens to be a disadvantageous situation for MSMEs has worked in favour of fintechs. Currently, many fintechs are optimizing this favourable environment by quickly disbursing funds and other associated services. It won’t be long before fintechs reign in the MSME lending market.
MSMEBlog discusses issues with finding suitable funding sources for MSMEs and guides them with the procedures to acquire the necessary financing. Visit MSME Blog website for more information on MSME finance.