MSME lending: Digital lenders, fintechs at crossroads amid COVID-19

Vivek Belgavi.

Vivek Belgavi

In India, MSMEs form the backbone of the economy as they contribute about 38 percent of GDP, almost 50 percent of total exports, and are responsible for 21 percent of overall employment in the country. COVID and the resultant country-wide lockdowns have hit the sector hard with an unprecedented reduction in demand, disrupted supply chains and lack of formal financing options to sustain their operations.

Over the last week, the Government of India has announced a slew of measures for MSMEs, which includes a collateral-free automatic top-up loan worth Rs 3 lakh crore, an equity support with the provision of Rs 20,000 crore as subordinate debt and also a Rs 50,000 crore equity infusion through a Fund of Funds mechanism.

As per International Finance Corporation estimates, the overall demand for both debt and equity finance by Indian MSMEs stands at Rs 87.7 trillion, of which the debt demand alone is Rs 69.3 trillion and formal sources catered to only 16 percent of the total MSME debt, i.e. Rs 10.9 trillion.

Given the lucrative market potential, several digital lending fintechs have entered this segment. COVID lockdowns have created massive challenges for these digital MSME lenders; however, some unique opportunities have also emerged, with the announcement of the stimulus package. These opportunities are around product and business model innovation and also around ecosystem collaboration in the digital lending segment.

Digital lending business models in red zone

In the COVID-19 aftershock, most MSME fintech lenders are facing a double whammy i.e. a shortage of funds from traditional co-lenders as well as the need to extend moratoriums to MSME borrowers. These digital lenders are taking a significant hit to their loan books with a massive reduction in fresh disbursements and collections slowing down. This, coupled with the tightening of purse by both the co-lenders i.e. banks and large-NBFC and the equity investors i.e. VC and PE firms, results in a double whammy in the form of liquidity crisis for the digital lenders, especially the early-stage fintech startups. This may result in a consolidation wave, in the form of buyouts or acqui-hires from well-funded fintech startups across segments and other lending institutions.

The tipping point for flow-based lending

In current times, when fresh disbursements have come to a standstill, cash flow-based lending can emerge as an alternate credit line for both fintech and traditional lenders to focus on. As opposed to asset-backed loans, a flow-based loan is backed by a firm’s existing and expected cash flows and in current times can help a lender assess the creditworthiness of a borrower.

The rapid digitisation of Indian MSMEs started after demonetisation and is expected to accelerate even further in the COVID situation. Several digital public infrastructure initiatives from the government and regulators such as UPI, Digital Locker, AePS, BBPS, GSTN, TreDs, etc. have established the bedrock for flow-based lending. Several well-funded startups from neo-banking, supply chain technology and bookkeeping segments have also aided the MSME digitisation. Further, when Account Aggregators (AA) get operationalised, digital lenders will have access to MSMEs’ cash flows in real time.

MSMEs from resilient sectors like healthcare, telecom and essential services supply chain or from sunrise sectors that are involved in the manufacturing of hand sanitisers, masks, gloves, head gear, bodysuits, etc. can still present significant opportunities to focus on. From point-of-sale machines to e-invoicing ledgers to digital bookkeeping Apps, fintech startups have an opportunity to use alternate data to understand the MSME business needs and cash-flow trends and service their lending requirements with solutions at various stages of the business cycle.

Innovation by digital lenders

The primary USP of digital lenders lies in their business agility to serve small businesses more quickly than their larger competitors with innovative and personalised products. Lending fintechs have launched innovative products such as ‘anti-lockdown loans’ with flexible repayment plans and ‘Digital Lending 2.0,’ providing contactless loans for affected businesses. Further, multiple payment and investment fintechs have expanded their offerings to include loan solutions such as P2P lending, quick settlement loans and easy loan facility for their merchants to navigate the situation.

Fintechs are also launching a suite of lending solutions to enable firms to digitise and use analytics-driven platforms to offer seamless loans to customers. Some digital lenders have also launched lucky draw coupons to encourage timely repayments to MSMEs.

Continued policy, funding support essential to sail through storm

Taking a cue from several advanced economies, where fintech startups have been utilised as the last-mile disbursement entities to MSMEs, a similar setup can be channelised through SIDBI or MUDRA Bank to provide a credit line to Indian fintech startups for distribution of financial benefits and relief to Indian MSMEs.

The RBI may also consider the recommendation of the UK Sinha committee report to extend the Video-KYC process to onboard MSME customers as well. Further, RBI Sandbox may also have a category for MSME-lending and allow digital lenders to innovate and experiment with flow-based lending products under its supervision.

In these unprecedented times, banks and fintechs will have to work in tandem to bring customised digital lending offerings to MSMEs while also ensuring that the maximum number of MSMEs are able to avail the benefits of through digital channels.

Vivek Belgavi is Partner and Leader Fintech at PwC India. The views expressed are personal. Sanjeev Kumar, Associate Director – FinTech, also contributed to this article.