The small and medium-sized enterprises (SME) sector, considered to be the backbone of the Indian economy, has more to offer than what meets the eye. It can be the desired growth engine which helps India achieve an ambitious two-digit gross domestic product (GDP) growth rate. In its current form, the SME sector contributes about 45% to the nation’s GDP, which is about three times the corporate sector’s contribution, and is estimated to have around 51 million units that employ more than 46 crore people. Yet, the sector faces a debt gap of Rs 2.93 trillion. This considerably limits its true potential.
The current challenges of the SME sector
A capital-intensive domain, the SME sector in India is often at the receiving end of a working capital crunch due to several reasons. They need capital influxes to trigger growth initiatives and are often operating in segments with unpredictable buyer demands. Business operations of Indian SMEs are also extremely inefficient—they often possess large inventories and take more risk in receivables which affects their overall efficiency. Their limited buying power also means that there are fewer creditors willing to extend working capital to SME businesses, and if they do, it comes at a prohibitive cost. Further, the GST has brought a level playing field for SMEs to grow beyond the earlier limiting geographic boundaries.
The advent of startups in credit fulfilment
A major portion of this working capital crunch is funded by credit, since equity options are very limited in the SME sector and is largely restricted to promoter equity, which is often already consumed in the business entity. Private equity is largely restricted to sunrise, high-growth industries having a ground-breaking business model, and most of the SMEs must wait for considerable scale to attract it. Institutional equity players, on the other hand, are subject to red tape and rigid regulations. On the other hand, institutional credit for SME businesses is relatively limited as these firms lack financial data and ratings, which can be used by creditors to assess their creditworthiness.
This is precisely where cutting-edge fintech startups with their revolutionary tech-driven approach can play a key role. Such startups use state-of-the-art technologies in order to facilitate crucial capital to the SME market. They primarily help SMEs in the following ways:
Efficient processing: The first wave of fintech startups, both in lending and services, developed fast and nominal paperwork-oriented systems for efficient processing and disbursal of loans to SMEs. They continue to heavily leverage technology in customer interactions, extracting data through online integrations (eg Aadhaar), and deploying rule-based screening engines for higher efficiencies and faster decision-making. LendingKart, for example, has pushed the envelope significantly with online processing and an automated decision-making process that promises disbursal within 72 hours of application.
Unconventional underwriting mechanism: Many fintech companies have invested significantly in data sciences to build proprietary scoring systems and databases which enable them to generate a credit report that is more credible, contemporary, and relevant. This alternate data set could range from current cash flows, anchor transactions, social networks, behavioural and community feedback, and offers a comprehensive view with high predictability. For Example, OfBusiness, which provides financing to SMEs, has built a proprietary underwriting approach based on an SME’s past transaction history with local distributors (operating credit) and other alternate data captured through the SME-anchor ecosystem. Whereas, startups as CreditVidya help financial institutions to build credit scores based on non-traditional data sources including behavioural, social networks and transactional information.
Creating a transactional marketplace: Several fintech startups have leveraged technology to build scalable solutions to connect SMEs to potential lenders for tailored requirements. In addition to connecting lenders to SMEs, these marketplaces provide several value-added services like primary underwriting, risk assessment, rule-based matching, and seamless payment-settlement engine to enable a win-win for SMEs and investors. Kredx, an invoice discounting platform, solves the cash-crunch for MSMEs by connecting them to retail investors looking for high short-term return on investment.
Non-traditional channel-led approach: While channel partnership for credit access in large corporates is common, many startups are now going deeper into the value chain and funding the supply chain of mid-tier corporates and venders of e-commerce platforms. With India’s ‘fat middle’, this is a hitherto untapped channel, and requires a tech-led business model for cost-effective acquisition and tailored underwriting based on partner data. For example, Indifi has built a specific product and underwriting engine for the travel segment. Capital Float, a hybrid marketplace that has raised $42 million in funds, offers flexible short-term loans and has built a strong e-commerce and services partner ecosystem including PayTM, Shopclues, eBay, Amazon, Mswipe, Uber, etc. Others building a strong offering for SMEs through this acquisition approach includes ABFL (Direct) and FlexiLoans.
The advent of such fintech startups is seen as a harbinger of positive change for the cash-strapped SME sector. Such firms stimulate capital influx into the sector while enabling it to effectively tap into the growth opportunities within the market. This is making SMEs financially more secure, spurring their growth in new and extremely favourable market conditions. Ultimately, it will catalyse the market activity in the SME sector, thus inching India closer to realising the long-awaited two-digit growth rate.
Asish Mohapatra is co-founder and chief executive of OfBusiness, an online platform that offers credit loans to the SME sector.