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Addressing the Great Indian Credit Gap

Introduction Indian MSMEs, for a long time, have been referred to as the backbone of the country’s economy. And the statistics seem to support it: there are about 6.

7 months ago

Latest Post Addressing the Great Indian Credit Gap by Akshay Nagpal public

Introduction

Indian MSMEs, for a long time, have been referred to as the backbone of the country’s economy. And the statistics seem to support it: there are about 6.3 crore micro, small and medium enterprises in the country, giving employment to more than 11 crore people, accounting for over 30% of the country’s gross domestic product with a 48% share in the country’s exports. That makes MSMEs the second largest employer in India, after the agriculture sector.

Although impressive, the numbers do not paint the true picture: Indian MSMEs face a number of challenges, which have only piled up in the past few years. Whether it was government-initiated reforms to check tax evasion, improve compliance or a push to go digital, it had a severe impact on the profitability, efficiency and in some cases, even the survival of these businesses. The adverse effects of these disruptions in the supply chain, coupled with the spikes in commodity prices lead to an inevitable increase in working capital requirements, as demand and supply further fluctuate.

The story of the Credit Gap

The biggest problem, thus, is the lack of access to funds, resulting in a cash crunch for a vast majority of these MSMEs. So critical is this problem, that 9 out of 10 MSMEs in India depend on informal sources of finance for their working capital requirements, as per the National Institute of Rural Development and Panchayati Raj.

This liquidity crunch has posed a very poignant challenge: a question of survival for most MSMEs. It is estimated that the total MSME Credit Demand in India stood at an eye-watering figure of ₹ 45 Lakh Crores (~$600 Billion), with this demand growing at a substantial pace year-on-year.

What’s more worrisome is the fact that without complete documentation, tangible collaterals and proper financials, getting access to funds from the formal sector is almost impossible.  And with a complete lack of credit history, a vast majority of these enterprises are forced to turn to the informal sector for funding.

This is where the problem is aggravated. Of the amount mentioned above, about 40% of it is met through informal sources. These charge exorbitant interest rates (2X the interest charged by the formal sources, on average), making financing an exorbitant affair for these MSMEs.

Apart from this, another 25% of MSME Borrowing is considered invisible- borrowings such as personal loans, including loans and advances- not sanctioned for the business. This highlights the inherent weakness in the current system of financing in India.

The Other Side

On the other side of this problem lie the cash-rich corporations, looking for increasing the returns on their treasury incomes. With interest rates remaining more or less stagnant over the past few years, it has become a challenge for corporations to sustain the return on their treasury incomes invested in bonds, FDs and other risk-averse assets.

These problems, faced by corporate buyers, also known as anchor companies, and their vendors can now be addressed with the onset of technology- Invoice Discounting- designed to enable buyers to earn a higher return on their treasury income (with a marked reduction in EBITDA), while vendors could readily get access to funds to optimise their working capital and address their liquidity woes.

The Digital Push from the Government

With the Government-sponsored push towards digitisation, formalisation and transparency, the lending landscape has drastically changed, especially over the past 6 years. This started with the introduction of the Unified Payments Interface, popularly known as UPI, followed in close succession by the Government’s demonetisation efforts and the subsequent introduction of the Goods and Services Tax, better known as the GST.

What these initiatives essentially did was push Indian corporates and the entirety of their supply chains towards a more transparent, cashless and compliant financial system. The Goods and Services Tax regime reported a healthy 50% increase in indirect taxpayer base, on account of GST registrations, with more than 92 lakh Indian MSMEs now being GST registered.

The Technology behind it all

When the formal sector of lending cannot cater to such a large portion of those who desperately need funds to survive, innovative, revolutionary new ideas are required to fill the vacuum that has crippled Indian MSMEs. Playing on their pervasive inability to access funds, FinTechs like Clear have leveraged technology to provide innovative solutions like Dynamic Discounting, substantially increasing their ability to fund their working capital requirements.

For as long as we can remember, businesses relied primarily on overdraft to finance their working capital requirements. This was because invoice discounting, without a technology-enabled discounting platform that provides a common ground for corporate buyers and their vendors to negotiate and arrive at a discounting rate, did not offer a practical solution to MSMEs. Older discounting models were, thus, marred by their inflexibility in providing discounts in a conducive, mutually beneficial manner. Traditional Discounting was primarily driven by vendor led sporadic requests for early payment as a last resort for funding their working capital needs.

Why Dynamic Discounting?

Traditional discounting was, thus, unable to offer accounts payable–centric alternatives to consumers, unlike dynamic discounting, that is conducive towards developing platforms that calculate discounts dynamically on a sliding scale, driven by days paid early and annualised percentage rate. This is what led to the installation of Dynamic Discounting as a substantially more flexible alternative to traditional discounting.

Additionally, an increasingly digitised supply chain, accelerated digital adoption, improvements in automation, significant adoption of e-invoicing and integration with Enterprise Resource Planning (ERP) systems led to the creation of an ecosystem, conducive towards developing platforms calculating discounts dynamically on a sliding scale, driven by days paid early and annualised percentage rate (APR).

The True Potential of Dynamic Discounting

India is perhaps the country most affected by late payments. And with an average time of 57 days taken to pay suppliers, there is an urgent need to accelerate the adoption of tech powered invoice discounting in the country.

With rapid advancement and adoption of cutting edge technologies, there is a plethora of opportunities awaiting Indian MSMEs, with the advent of Dynamic Discounting. And as technologies become more democratised and accessible, the practical applications they potentially bring to the table are enormous, and can only lead to more transparent, secure and seamless transactions.

As they progress towards a common platform for discounting invoices, they gain access to finances that can radically transform businesses, and improve their productivity and efficiency.

Akshay Nagpal

Published 7 months ago