MSME Digital Lending Gains Momentum In the last few weeks, we have also seen many startups in the space raising fresh rounds of funding.

As the Micro, Small & Medium Enterprises (MSMEs) are bouncing back to business, the MSME digital lending space seems to be growing like never before. According to the NeoGrowth MSME Insight Report 2022, MSMEs credit demand in Bengaluru and Chennai has exceeded pre-pandemic levels and the MSMEs have bounced back stronger post-pandemic. In fact, in the last few weeks, we have also seen many startups in the space raising fresh rounds of funding.

On June 7th, FlexiLoans announced that it raised nearly $90 million in Series B funding from marquee investors including Denmark-based PE firm MAJ Invest, UK based fintech investor Fasanara Capital, among others. Same day, we also saw Micro MSME fintech ARTH securing $2.5 million in funding led by DEG – Deutsche Entwicklungs- und Investitionsgesellschaft/subsidiary of KfW, MIT Alumni and impact-driven US and Canadian angel investors. Last month, neo-banking platform Open Financial Technologies raised $50 million in a Series D funding round led by IIFL Finance to become India's 100th unicorn.

Why is the space buzzing

According to the ministry of MSME's annual report 2020-21, India has approximately 6.33 crore MSMEs that contribute significantly to the country's productivity and employment. However, nearly 40 per cent of credit allotment to MSMEs in India has been through informal channels.

"A key reason why MSMEs are unable to secure institutional credit is due to the fundamental challenges in the way institutional credit products are structured. For instance, traditional loans have no correlation of repayments to business performance i.e. monthly payments are fixed irrespective of business performance. This can work for large companies for whom debt servicing forms a small percentage of their monthly expenses however for MSMEs this can very well be a core factor for survival. One-quarter of a tough business environment can cause stress in repayments which in turn impacts the MSMEs' ability to raise credit from institutional channels," said Ashish Singla, co-founder and managing partner, N+1 Capital, an institutional credit provider.

This has opened up many doors for digital lending players such as Cash Suvidha, Aye Finance, Lending Kart, Indifi, Flexiloans, Open, Namaste Credit, among others. In fact, digital lending increased 12 times between 2017 and 2020, says RBI data. Digital lending to MSMEs is projected to increase between 10 and 15 times by 2023, scaling up to Rs 6-7 Lakh Crore ($80-100 billion) in annual disbursements.

The pandemic provided further impetus to MSMEs to digitize and accept the digital lending route to meet their credit needs. "Digital lending has become more accessible and accepted. This is further simplified through the ecosystem-based approach to lending that functions on the bases of partnerships at both the demand and supply sides of the lending spectrum," said Alok Mittal, CEO and co-founder, Indifi Technologies.

The pandemic has accelerated the growth in space to a large extent. "India has one of the lowest credit to GDP ratios (56 per cent) compared to emerging market peers with average credit to GDP ratio of 135 per cent . We believe this gap combined with a strong digital data trail which MSMEs now have, offers a tremendous opportunity for new-age credit providers to tap into," added Singla.

In 2020-21, when the demand went down for MSMEs, they were badly in need of quick easy loans. This is when startups rose to the occasion and helped them not only survive, but also scale up by adopting technology.

"Since the business cycles of most MSMEs, especially those in the micro MSME sectors were disrupted, getting credit through traditional financial institutions became even tougher. Digital lenders have had the flexibility to adapt to new normals, re-align underwriting to post-pandemic situations and offer credit to MSME players. Pre-COVID too the FINTECHs largely were focused on building capabilities to assess the customers around their cash flows rather than the security they have to offer as has been the case for traditional entities. This trend has continued post-COVID too," said Shweta Aprameya, founder, ARTH.

According to a recent report by BCG-Omdiyar, more than 75 per cent of MSMEs were comfortable using online means to reach lenders, with more than 50 percent being comfortable in giving lenders access to statements online. Some startups also opted for Buy Now Pay Later (BNPL). For instance, Actyv.ai, which was founded in 2019 offers a BNPL feature to MSMEs for their B2B transactions.

"Nearly 40 per cent of the new customers added in the Bureau in the last five years have been lent by the fintech startups. So massive is the impact of the Indian fintech startups. The Indian fintech startups have brought ease, access, intelligence and platforms that are enviable and replicated the world over. The fintech startups in lending, insurance and neo banking have really played the role of getting the new financial services customers to avail these services with their unique seamless customer experience," said Manish Lunia, co-founder, Flexiloans.

Customers are now hooked and over 20 per cent of customers in India only have a digital banking experience now and is expected to double over the next few years, he added.

The edge over traditional lenders

As mentioned above, traditional lenders offer loans based on collateral and this makes it difficult for MSMEs, who work on limited cash flow, to approach traditional institutional lenders. Startups have understood this challenge and have been leveraging deeptech such as artificial intelligence (AI), machine learning (ML) and data analytics to offer collateral-free loans.

They are able to offer customized loan products to the sector. The loans are approved through automated processes and borrowing firms need not have a great credit history. For instance, FlexiLoans has developed alternate credit assessment tools to underwrite these MSMEs based on their digital sales, purchases, cash flows and provides them digitally, thereby servicing over 1600+ cities in the country.

Overall, startups offer fast and hassle-free access to these businesses. "Further, the ability to link debt repayments to the business performance and building in flexibility are the key differentiators to traditional institutional lenders. Other than this quick TAT, Offering the ability to borrow multiple times and relying on digital data are some other differentiators," said Singhla.

"As per many surveys conducted on the MSMEs recently, 60-80 per cent of Indian MSMEs either sell or collect online. The pandemic accelerated the pace of technology adoption for MSMEs in accounting, bookkeeping, online selling and transacting. Likewise, we see over 1,00,000 merchants discovering us digitally per month and trusting the seamless credit experience. 100 per cent of the collections are digital and a substantial amount of customer journeys are automated," said Lunia.

Time to address the challenges

Startups and VCs supporting these startups have certain concerns as well. They believe that since the startups in the MSME lending space are driving financial inclusion and are creating alternate mechanisms using technology to underwrite these MSMEs, they need strong support. This should come in the form of preferential access to data from banks, GST data and tax data. They further demand cheaper costs of funds, and government guarantees like Mudra which are only available to profit-making large financial institutions.

"Most large financial institutions have not really embraced the fintech customer journeys but a right partnership-enabled environment can significantly benefit the sector," said Lunia.

They believe that with the upcoming Account Aggregator platform, one of the challenges of periodic access to MSME Financial Data, which has been cumbersome, can be resolved. However other than that, other hurdles need to be resolved and educating MSMEs on the availability of such new forms of lending is also key.