Online loans – the liquidity lifeline for MSMEs
Financing is an ongoing challenge for micro, small and medium-sized enterprises (MSMEs) around the world, and even more so in developing countries.
According to the International Finance Corporation (IFC), nearly 65 million enterprises, or 40% of formal MSMEs in developing countries, have unmet financing needs amounting to $5.2 trillion per year, or 1.4 times global loans to MSMEs. The inclusion of informal enterprises can significantly increase these numbers.
The UK Sinha Committee, constituted by the Reserve Bank of India, estimated that the credit gap for MSMEs in India was between $267 billion and $334 billion in 2019. The gap persists despite several measures taken by the government to strengthen formal funding channels. In December 2021, the share of bank credit to MSMEs was only 13%.
In the wake of the pandemic, the government has introduced a series of measures to keep Indian MSMEs afloat. Additional loans, equity injections, credit guarantees, etc. supported them on crutches of short-term financial aid. Thrown deep, some sank, but many MSMEs learned to swim.
The recent ICRIER report titled “MSMEs go digital” identified the first signs of a structural shift towards digitalization. Lockdowns and mobility restrictions have encouraged many MSMEs to opt for online channels. E-commerce companies reported an 80-90% increase in seller registrations on their platform around the second half of 2020, most of whom were from smaller cities.
The success was reflected in the increased percentage of online sales, improved turnover and profits. The benefits of digitization have trickled down to other aspects of business modernization, including inventory management, product cataloging and, most importantly, access to new sources of finance through online lending platforms.
Online lending platforms, guided by their data analytics and machine learning approaches, are able to offer tailored lending products to the MSME sector. They are lean, decentralized and effective channels for targeting under-penetrated markets. Mostly unsecured, online loans to MSMEs can range from short-term working capital to long-term business loans that are approved through automated processes, even when borrowing businesses have no track record. strong credit. Prominent examples of online lending platforms serving MSMEs include Lending Kart, LenDen Club, Cash Suvidha, Indifi, Flexiloans, Aye Finance, etc.
Interestingly, many platforms are partnering with e-commerce companies creating a supportive ecosystem for MSMEs who register for online sales on e-commerce platforms. A few years ago, e-commerce companies largely facilitated financing for their MSME vendors through banks and other financial services companies. But competition from online lenders offering faster and more efficient access to finance has opened up a whole new window of opportunity for struggling businesses.
The three-way arrangement between the e-commerce platform, the online lender and the MSME is a win-win situation. For e-commerce businesses, channeling funding to a seller improves their ability to produce and deliver high-quality products to buyers on their platform, which in turn strengthens network effects.
For MSMEs, it is access to cheap and fast loans that help manage inventory, expand market reach, hire new employees, modernize business processes, and more. ; and for the online lending platform, this is a business opportunity, the risks of which are partly mitigated by data-driven credit determinants and partly by the security that the platform e-commerce can offer. Online lending platforms surveyed for the “MSMEs Go Digital” study highlighted the symbiotic virtues of this arrangement.
According to data from RBI, digital lending grew 12 times between 2017 and 2020. Online seller financing, a subset of digital lending, is booming. But there are risks. The 2021 Report of the RBI’s Digital Lending Task Force I highlights the role of technological innovations in enabling financial access, albeit at the cost of greater reliance on lending services. unregulated third-party lending that lead to mis-selling, invasion of privacy and other unethical business practices.
According to the task force, 600 of the 1,100 loan applications reviewed could be classified as “illegal in nature.” This report provided a framework that balances the twin goals of innovation and systemic integrity. Some of the proposed measures include a verification process, self-regulation, basic technology standards, regular audits, new legislation targeting illegal lending, etc.
The current landscape is a mix of regulated and unregulated entities – NBFCs taking and not taking deposits, peer-to-peer lending platforms, etc., which create opportunities for regulatory arbitrage. For the market to remain competitive, a balanced approach and preventive regulation will be necessary.
Additionally, these first-generation online lenders have yet to experience a full cycle of growth and are far from market maturity; a journey that will include episodes of defaults, non-performing loans, capital risks, etc. An adaptive policy can help overcome these challenges.
The growth of MSMEs and their digitization is highly dependent on the availability and diffusion of credit, especially in underserved markets. A recent paper by Jing Cai and Adam Szeidl, finds that financing MSMEs should not be seen as financed businesses stealing business from unfinanced ones, but through a broader lens of social returns on capital , demonstrating increased consumer gains from MSME financing manifested in new product introductions, lower prices, etc.
It is therefore in the interest of policy makers to provide all available support for financing to reach MSMEs. Digital lending platforms are well positioned to bridge this credit gap. For this, policy makers and regulators must remain adaptive and agile.
The author is a Fellow of the Indian Research Council on International Economic Relations. Views are personal
April 13, 2022