OPINION: Why NBFCs remain key to closing the MSME credit gap

OPINION: Why NBFCs remain key to closing the MSME credit gap
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It is widely acknowledged that the micro, small and medium enterprises (MSME) sector has become the central nerve of India’s economy in these past few decades. The glaring asymmetry between the MSMEs that require credit and those that receive it has also not gone unnoticed. NBFCs have become a pivotal part of the mechanism in closing this gap, by widening the reach of financial services thereby enhancing MSMEs’ resilience.

NBFCs are slowly but surely gaining a foothold in the Indian financial system. They are the biggest receivers of funds on a net basis, even surpassing banks. The double-digit growth in credit that NBFCs accomplished while banks were facing a decline in credit as a result of asset quality stress, should be an indicator of their central role as credit providers in India’s financial system. Within the MSME lending segment, NBFCs have witnessed a stable 13% market share (as of 2020). NBFCs are increasingly preferred by borrowers owing to their increased ability to reach remote areas and in making quicker decisions, providing prompt services and having expertise in niche segments.

According to the World Bank Programme appraisal document for the Raising and Accelerating MSME Performance (RAMP) programme, over 40% of MSMEs lack access to formal sources of finance. As a result of lacking proper accounting systems, updated financials, and proper documentation, a large number of MSMEs borrowers are excluded from the traditional lending ecosystem. From the perspective of larger lenders, thin-file customers often require a greater degree of support and hand-holding. This combination of smaller ticket size geographical dispersion of such MSMEs makes it economically not viable to serve these markets.

For India to step confidently into the future, servicing the credit needs of India's 60 million MSMEs without any access to formal credit is paramount. Digitally-led NBFCs remain key in this mission as in their case. They are expanding access to credit through credit models like the cash flow based model. This makes such NBFCs the go-to lenders for borrowers who have the means but are disqualified as per the traditional credit assessment process. There is an evolution of partnership models between NBFCs leveraging their distribution strength and superior customer underwriting with larger banks that have cheaper capital and better risk management processes. Such access to credit is further augmented by digital lenders that have built efficient and scalable outreach to credit-starved MSMEs. The data driven credit models such digital lenders use allow better risk calibration. This is demonstrated by the improving credit performance of these lenders after the Covid-induced stress.

Online NBFCs and digital SME lending: Key step towards universal credit access

Online NBFCs are taking this aim of reach and access one step ahead through tech-enabled solutions. They have widened the scope of what credit could be, and enabled the reach of credit to underserved customers across different parts of the country. Leveraging alternate data sets, innovative approaches to credit underwriting and offering customised products with a lower turn-around time have also made digital lenders more suitable in enabling access to credit to the MSME borrowers. They are displaying a new confidence in lending to small businesses through varied approaches. One such approach is ‘ecosystem-based lending’. Accessing business loans that are digitised end-to-end is logistically easier for MSMEs that are in tier 3 & 4 cities and may not have the same bank branch options that bigger cities do. The ecosystem based approach to lending involves partnering with digital ecosystems such as Amazon, Google Pay, Zomato and leveraging the information about the MSMEs available with these technology platforms. The approach also allows usage of segment-specific indicators around revenue, customer ratings/reviews, and transaction business volume to arrive at a composite credit model.


Thus, proprietors in small towns can seamlessly access credit that was previously available to them in only physical bank branches that are flush with liquidity but inaccessible to MSME borrowers. This access has further been enhanced through solutions like E-NACH, CKYC/OKYC, E-Sign, Video Sign. The alternate data sets digital lenders use for credit modelling sidestep the need for collateral and documentation that many MSMEs may not have. This is how an ‘ecosystem-based’ approach to lending takes accessibility one step further.

There is still much distance to be covered in terms of completely closing the MSME credit gap. The onus falls on start-ups and the innovation ecosystem to create digital tools and strategies that leverage MSMEs digital footprints and ecosystems. Regardless, in terms of reaching the fringes of the financial system, NBFCS (both online and offline) are rightfully giving credit where credit is due.

The author is the founder and chief executive officer (CEO) of online lending firm Indifi Technologies.

Disclaimer: The opinions expressed are of the author and do not necessarily reflect the views of the Business Insider India.