As the steady rising day temperatures call out the ending of the winter season, Pradeep Kumar is on his way to start another busy day. As a retailer of consumer camera equipment, he has established a good presence both on ecommerce platforms (that is responsible for about 30% of his sales) in addition to his small store in Delhi’s Lajpat Rai market. He is expecting a big surge in sales as the school holiday season is expected to start driving up demand for cameras and associated ancillary products. He needs to stock up on inventory and needs about Rs 10 lakhs urgently to secure his supplies from the distributor.
Till last year, this meant doing the rounds to a few known lenders and spending at least 2-3 days doing the paperwork without knowing for sure when and how much he would be able to borrow. However, today, the balance has shifted in his favour as he has a choice of lenders to choose from, and a clear visibility of how much he can borrow at any given time. The best part is that he does not have to leave his shop — and as a bonus, the actual funds are available to him in almost real time.
At almost, the exact same time, Sushila Chanu, a beauty salon owner in Imphal, is constantly struggling with the need to maintain her popular outlet with the latest trends in the fashion industry. She operates in what is mainly a cash-dominated economy and most of her interactions with her customers as well as with her suppliers have so far mostly been in cash. She is looking up to redo the interiors of her salon and also invest in some of the latest styling products. She estimates that she needs about Rs 4 lakhs to undertake this. She has learnt from her sources that there are many willing lenders, but she will have to take out the time to submit paperwork, do the necessary follow up and hope that her loan application is approved. The other alternative is the local money lender, but the interest rates deter her from taking that option.
Pradeep and Sushila are prime examples of millions of Indians across the length and breadth of this country who constitute a vital sector of the economy in the MSME segment. The MSMEs (Micro, Small and Medium Enterprises) contribute to almost half of the total industrial output and a fifth of the GDP. The sector is also responsible for the huge employment generation in the economy. Nevertheless, the MSME segment faces significant challenges as it is diverse, does not have regular accounting practices, depends on the skill/expertise of a very few people within the enterprise. Therefore, this sector has lacked access to formal credit and relies on informal players who have a share of more than 40% of lending to this sector.
From working capital requirements to capital for capacity expansion, and trade related financing, this sector has many requirements from the financial services sector. However, as established earlier, it is not easy to lend for these requirements since the process of lending involves sourcing of credit applications, evaluation of the proposal, loan limit determination, pricing and actual servicing of the loan, all of which in the traditional model has involved significant amount of paperwork, strong expertise in specific industry segments to support such operations. This means that till now, coverage of MSMEs has been poor due to fragmentation, their interest has also been low due to high costs of managing the lending supply chain. In Addition, the use legacy technology tools have also been a limitation for MSMEs.
In the world of digital transformation in the lending space, we are witnessing a completely changed environment. It is estimated that the total potential for lending to this sector is today close to $100 Bn in annual disbursements across the 60 million MSMEs estimated in India.
Digital lending is transforming this sector at a pace historically never seen before. What is driving this change? Formalization of a large part of this economy especially in the Rs 10 lac and above annual turnover due to GST and other reforms has led to increased digitization of accounts, usage of banks, and adoption of smartphones.
On the supplier side, digital transformation is here to stay. Various banks and lenders and fintech firms have established a robust and real-time digital ecosystem that leverages India stack, and API based interactions. These provide rich customer experience to the borrower but more importantly cuts down the credit application to disbursement timeframe to a few hours, significantly reduce the cost, and all with minimal paperwork and without the need to appear in person.
In the near future, the lenders will be able to turn on mass-customization to fine tune the product as close to the customer specific needs. Customer acquisitions will increasingly shift away from the distributed physical network and start to leverage supply chain ecosystems such as ecommerce, trade groupings and smartphone adoption will further accelerate this shift. Data processing at scale will also provide adequate inputs for analytics and the ability to tailor offerings to customers as well as help with fraud reduction.
The areas where there may need to be more emphasis in the coming days, include: having a Payments Service Directive-2 (PSD2) type mandate that allows for consent-based sharing of customer data, digitization of the underlying physical securities so digital records can be directly accessed for processing, and differentiated credit scoring mechanisms which can be formally adopted parallel to the current credit scoring model. With these steps and more, one can see how digital lending can vastly aid the MSME segment.
This is the tale of many Indians, but between Pradeep moving towards realizing the digital potential to Sushila still in the discovery phase of what is possible, we are straddling the biggest opportunity in the country with MSME landscape.