The second wave of the COVID-19 pandemic has stopped in its tracks the green shoots of economic recovery that were visible. Simultaneously, it induced a triple crisis of disrupting the supply chain, demand, and workforce for India's fragile Micro, Small, and Medium Enterprises (MSMEs), which are often cited as the backbone of the Indian Economy. While MSMEs were already finding it difficult to manage their cash flows including the rigorous lending criteria of banks and non-banking finance companies (NBFCs) with limited assets to use as collaterals, this disruption meant a double whammy of further delay in settling of their receivables as well as lenders becoming more risk averse. While the government and the Reserve Bank of India (RBI) announced a slew of measures, including the issuance of credit schemes and calling out financial institutions to adopt cash-flow-based lending, yet the transmission of these relief measures to a majority of MSMEs remains a challenge. This highlights that the crux of the problem is not the lack of schemes, rather the informal nature of MSMEs and lack of organised set of financial documents, which casts a unique challenge for lenders to assess the creditworthiness of these enterprises. Today, just 40% of the sector’s credit demand is met by formal credit. Add to that the information asymmetry between the data available for MSMEs vis-à-vis large and mid-sized corporates where the lenders’ tend to apply the same lens of existing credit-risk assessment processes to MSMEs to those applicable for larger corporates. This often multiplies the operating cost for lenders to serve MSMEs as compared to the return on their loans. Though this scenario and the increasing credit requirements of MSMEs point to a colossal credit gap of ₹ 30 lakh crore, it underscores the critical role financial technology (FinTech) companies and new-age lenders can play in supporting MSMEs to adapt to the changing reality and respond to the challenges. <cmsannotation type="cmsannotation" annotationid="Capitalising on creditworthiness" comment="subhead" text="Capitalising on creditworthiness">Capitalising on creditworthiness</cmsannotation> The marriage between technology and financial services provides digital lenders an opportunity to focus on making MSMEs profitable and creditworthy. Alternative sources of data, such as cash flow, utility bill payments, point-of-sale transaction records, and even information from e-accounting programs can help put in place a comprehensive model to assess MSMEs’ business health. Further, by incorporating Artificial Intelligence, Machine Learning, and analytics into these models, lenders can build a more accurate financial health model with a comprehensive credit risk profile to detect and mitigate fraud and NPA risks. <cmsannotation type="cmsannotation" annotationid="Unlocking cash flow and reducing days sales outstanding" comment="subhead" text="Unlocking cash flow and reducing days sales outstanding">Unlocking cash flow and reducing days sales outstanding</cmsannotation> In addition to simplifying the lending process, innovative technology leveraged by FinTechs can enable electronic invoice presentation, processing, and reconciliation that will also help in better credit monitoring. Considering that chasing late payments is a tiresome process that leads to locked up working capital, e-invoicing can help in significantly removing procedural delays resulting from manual processing of invoices. It also reduces the time required to make and receive payments, gives a real-time status of pending invoices, and helps release locked up cash flow. In addition, MSMEs can also leverage these e-invoices to avail loans instantly, as the process to verify the genuineness of invoices by lenders can be reduced significantly. <cmsannotation type="cmsannotation" annotationid="Financing through digital supply chain platforms" comment="subhead" text="Financing through digital supply chain platforms">Financing through digital supply chain platforms</cmsannotation> Digitalisation of supply chains has been a game-changer for MSMEs that has enabled faster liquidity for them. While banks continue to assess creditworthiness for collateral-based lending to MSMEs, new-age lending platforms can digitally evaluate transaction data through AI-driven credit models in near real-time and offer trade financing products and services contextualised to the parties involved in the trade. Some platforms allow integration of their products and services into banks’ MSME platforms, which can subsequently be offered to MSME customers through digital medium. While no one solution can bridge the existing credit gap for MSMEs, leveraging alternative financing tools, such as e-invoice financing, peer-to-peer lending, and TReDS can go a long way in addressing this issue and create an enabling environment for MSMEs. Further, with the COVID-19 pandemic continuing to disrupt economic activities worldwide, FinTechs, banks, and NBFCs will have to come together to build differentiated lending models to forge the right balance for financial stability and create solutions for the credit needs of MSMEs. 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Narayan ‘Naru’ Ramamoorthy

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Cash, capital and credit trickle down to small businesses at a frustratingly slow pace — tech can speed them up

Narayan ‘Naru’ Ramamoorthy