formal credit capital

This blog is written by our guest author, Hardika Shah – Founder and CEO at Kinara Capital.

The Micro, Small and Medium Enterprise (MSME) sector, without a doubt, is the backbone of the Indian economy. While many of the MSMEs  may be smaller in scale, their economic impact is profound. Contributing a lion’s share of 30% to the GDP and more than 40% of India’s exports, a lot of economic prosperity hinges on the growth of MSMEs. Yet, there are a few systemic challenges within the financial ecosystem, especially around formal credit, that inhibit the growth of these enterprises. After all, capital is the lifeblood of any business, and lack of access in this regard is highly challenging. 

The Underlying Issue 

Right from operational and infrastructural challenges, there is no denying the existence of systemic challenges that has led to the MSME credit gap. Especially post-pandemic, the need has risen. Of more than 63 million MSMEs, 80% of them lack access to formal financing. The main challenge is the requirement of land or property collateral required by most traditional lenders. Add to that, there is lack of formalization which removes access to capital. 

With an estimated credit gap for MSMEs at Rs. 25.8 trillion, it is safe to assume that credit disbursal to the sector is sluggish. Naturally, MSMEs with the zeal to succeed resort to alternate solutions, which often takes the form of unreliable and costly informal credit

Challenges Faced By MSMEs When Accessing Formal Credit

The MSME credit gap exists for several reasons and the sector is rife with challenges. The key issue here is the lack of property or land collateral which many banks require in order to issue a loan. This devolves to reliance on informal credit, where moneylenders tack on absurd interest rates, effectively stifling growth. 

Besides collateral, lack of formalization is also a challenge. The existing credit ecosystem isn’t entirely inaccessible but many of the underserved MSMEs routinely rely on informal practices. Much of it has to do with low financial literacy, inadequate familiarity with fintech and digital solutions, and aversion to paying taxes and formalized business practices of following local and state compliances and registrations. In many cases, this is because the informal way of running a business has quick turnaround times, doing little, if anything, for the progress of the sector. 

This is one instance where a lack of awareness from the MSMEs contributes to, and even compounds, the existing issues with credit accessibility. Thinking that avoiding formalization is taking the easy route is a misguided notion. In the long run, MSMEs suffer as they can’t build a credit history and  informal sources are not reliably available when a business need arises. 

Credit Lines Available To MSMEs: A Dearth Of Reliable Options

For MSMEs in growth stages, lack of capital can be a serious problem. Many usually turn to family & friends, or moneylenders, however, this is far from ideal as it is not a reliable source of capital and can be costly without any consumer protection afforded to the borrower. Many MSMEs don’t have enough reserves or means to qualify for a loan from traditional banking institutions. 

This issue only worsens for women entrepreneurs, for whom gender bias is an ever-present roadblock in the pursuit of capital. Reports and industry data have found that less than 20% of women in India have land ownership to offer as collateral.

Women are more likely to face delays and rejections when trying to avail a business loan. According to IFC, the rejection rate of lending institutions for women entrepreneurs in India is 19% compared to 8% for men-owned businesses.  Much of this issue boils down to the fact that these aspiring entrepreneurs aren’t taken as seriously as their male counterparts.  

Rooted in RBI regulations and strict governance, access to formal credit provided by regulated NBFCs  affords MSMEs the benefit of collateral-free financing to help them grow their business while providing consumer protection and grievance mechanisms. The alignment of stakeholder resources toward the already identified problems has huge potential to spur favourable policy reform. With better governance, the millions of  MSMEs left out of the formal credit sector will have a better route to affordable financing. This effectively minimizes instances of fraud, which is commonplace in the informal setting. 

An Enhanced Credit Ecosystem: Impact On The MSME Sector 

Considering the contributions to the GDP, the MSME sector deserves a better credit ecosystem, one where reliance on the informal isn’t expected or the norm, and this is where I believe that fintechs can play an important role. Modern lending can rely on digital and tech solutions for better and faster loan decisioning, and disbursements, and take a data-based credit underwriting approach which can lower the risk of unsecured lending. 

Digital processes, quicker disbursal windows, transparency in regulation and pricing policies, and better service are all noteworthy perks brought to the table by modern fintechs. This eases the act of expanding the business and will lead to wider financial inclusion.

Proactive Efforts Bolstering Formal Credit Inclusion 

Ever since my first assessment a decade ago, it was clear that more could be done to bolster financial inclusion for MSMEs. Today, through Kinara Capital, we’ve created a technology-enabled financial solution that solves for the MSME needs of today and tomorrow. Addressing key pain points for MSMEs looking for formal credit, we have not only put the offer of fast and flexible collateral-free loans on the table but made it accessible. Currently, Kinara Capital has disbursed over INR 3,000 crores across 75,000+ loans.

A similar endeavour is being led by our partners CredAvenue who have also been a force of development, paving clear, more structured debt solutions for the enterprises of the nation. Their digital-first approach establishes transparency and reinforces existing credit systems. In building India’s first and largest de-facto operating system for the discovery, investment, and fulfilment of debt solutions, CredAvenue promotes fair access to credit for MSMEs – all in a bid to bridge the credit gap and #LeverageIndia to its maximum potential. 

As was expected in 2021, cash flow-based lending would be the key to realizing MSME financing objectives. Today, through alternate data appraisal systems, this model is a reality and provides much-needed hope for a more inclusive system. 

A Brighter Future: The Evolving Formal Credit Ecosystem Of India

With the pace at which Indian fintechs are evolving, it isn’t a stretch to say that formal credit will become even more readily accessible for MSMEs in the near future. While traditional institutions are upgrading to better serve the sector, standalone private lenders are leading the charge. Ultimately, this bodes well for the Indian MSME. Formal credit channels are slowly improving by leveraging AI & ML models to streamline access and underwriting, increase the mobilization of business finance, and ensure capital is disbursed quickly and reliably. With more capital, MSMEs, both in the urban and in the rural India, are in a better position to leverage sectoral opportunities, while easing the act of conducting business. 

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