How fintechs, banks and government can reduce the cost of loans to MSMEs and improve accessibility to credit

Despite the significant contribution of MSMEs to the country’s GDP and overall growth, these actors struggle to obtain loans from formal sources. (Image: pixabay)

Credit and financing for MSMEs: The MSME sector has remained a key driver of large-scale job creation and also a lucrative hub for innovative startups in India. Home to 60 million enterprises, this sector accounts for 33 percent of total manufacturing output, 45 percent of exports and employs around 80 million people in the country. However, most businesses in this space have been under the impact of uncertainty and shattered supply chains with the advent of Covid-19 which rocked the world like never before.

The pandemic has exposed pain points for these businesses, where liquidity is high on the agenda for most small business owners. The two main reasons behind this problem are the availability and the cost of capital. These challenges lead small businesses to approach informal lenders by mortgaging their assets. This is what makes it difficult for financial institutions to assess and analyze the credit risk of these players.

Government relief measures

To provide some relief, the government has rolled out liquidity measures such as Targeted Long-Term Repo Operations (TLTRO 2.0), Partial Credit Guarantee Scheme (PCGS) and Line of Credit Guarantee Scheme. emergency (ECLGS), among others. However, due to the lack of transmission by small NBFCs and fintechs, the expected benefits of these support programs have not reached most players.

PCGS: Existing problems and solutions

Speaking of PCGS, which guarantees a 20% loss guarantee on bond / CP issuance from non-bank lenders, it has been found that most PSBs limit its use, making it accessible only to their existing NBFC borrowers. , with whom they did business. earlier. The problem with this approach is that it directly excludes new lenders – especially those from the BBB and A rating families – from using the benefits. Apart from these players, some PSBs have already reached their exposure limits on NBFCs, preventing them from reaping the benefits of the scheme.

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The original PCGS system enabled the purchase of pooled assets by offering buyers a direct charge on the assets. This eliminated the entity risk from the NBFC. Therefore, the government should reintroduce the element and add it to the current regime. We need to understand that the risk profile of bonds is far superior to the underlying credit rating of fintechs because the pooled assets offer a 20% sovereign guarantee. The government should also ensure that bonds purchased under this scheme are exempt from sector limits for banks with respect to exposure to the NBFC. This will build the confidence of PSBs and encourage them to step out of their existing relationship with the NBFC. In short, PSBs should be mandated to extend their support to all qualified players on the back of solid safety and security, given the guaranteed nature of the pools.

ECGLS: Existing Problems and Solutions

Likewise, ECLGS was launched to put liquidity in the hands of struggling MSMEs during the Covid crisis. The program was offered under a 14 percent interest rate cap by the NBFCs, with no allowance for processing costs. However, since most NBFCs and fintech players have a cost of wholesale funds in the range of 14%, they could not lend money to borrowers. The lack of liquidity of these players also prevents them from using this scheme. To meet this challenge, the government can make funds available to any interested lender at a reasonable cost of capital (8-10 percent).

In fact, the government can provide 100 percent liquidity support for this plan through SIDBI. Another way to make this support available is to isolate loans that fall under this scheme and pledge their cash flow to wholesale lenders as part of a bankruptcy-resistant safety net. In addition, the government can also make the mechanism of obtaining a notice of compliance from existing lenders frictionless and hassle-free. For example, if a borrower submits an NOC letter under this program to a lender and does not receive a response within seven days, the NOC should be considered in such a case. This will allow competent lenders to disburse funds to borrowers more transparently, rather than keeping them in queues, which would only cause further delays.

At the same time, most digital lenders continue to borrow above 14-15% despite quality ratings, which in turn results in a high cost for borrowers (over 20%). Since the ECLGS has a cap rate of 14%, digital lenders are no longer eligible for these programs. To address these bottlenecks, the government can allow direct lending on digital platforms by PSOs, where the underwriting process and control would remain with the bank. Likewise, the government can also facilitate wholesale loans to fintech NBFCs, so that PSBs can take the initiative to develop an alternative qualification process for these players. In fact, SIDBI’s fintech pilot is already doing it.

Fintech: closing the credit gap of MSMEs

Despite the significant contribution of MSMEs to the country’s GDP and overall growth, these actors struggle to obtain loans from formal sources, mainly due to the inability of the banking system to assess their creditworthiness. However, fintech players are changing that by providing easy and affordable loans to these underserved businesses and using data-driven models to calibrate credit risk. However, most fintech players continue to borrow at rates above 14-15%, which ultimately translates into high costs – over 20% paid by MSMEs. This high interest rate limits the growth of these companies.

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One of the solutions to this problem may be collaboration between fintech players and public sector banks. With this association, FinTech companies can extend the reach of PSBs, while providing them with better credit decision-making tools. Likewise, institutions such as SIDBI and DFIs can leverage their rich experience in developing credit enhancement products to enable a continuous flow of capital. This can be a major boost for businesses in Tier II and III locations and for those looking for loans below Rs 10 lakhs. Additionally, if the government can extend refinancing programs to younger NBFCs without a three-year record of profitability, it will be able to assist MSMEs with smaller, shorter-term loans.

PSBs may also consider creating a corpus for relatively younger and lower rated NBFCs by developing an alternative qualification process and threshold. These are some of the measures that can provide respite for the affected MSME segment and help businesses return to the new normal, as soon as possible.

Alok Mittal is the co-founder and CEO of Indifi Technologies. The opinions expressed are those of the author.

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