By Joydip Gupta

India’s micro, small, and medium enterprises (MSME) sector is a cornerstone of the economy, contributing significantly to employment (over 15.5 crore), exports (45% of all exports), and GDP (29% of total GDP). However, these enterprises face substantial barriers to accessing formal credit, hampering their growth potential. To foster a more inclusive MSME sector, it is imperative to address these challenges and implement strategic initiatives that leverage advanced technologies.

Lack of Credit History and Data Diversity: Many MSMEs struggle to access formal credit from traditional financial institutions due to insufficient credit history and the complexity of their financial data. This data often comprises a mix of structured and unstructured elements, including bills, inventory records, GST returns, payables, receivables, cash flow statements, bank transactions, and even SMS communications. This amalgamation complicates the assessment of creditworthiness for these businesses.

Irregular Cash Flows: Businesses in sectors like agriculture and retail frequently experience seasonal or irregular cash flows. This variability makes traditional lenders hesitant to extend credit, as they often prefer borrowers with stable and predictable income streams.

Geographic and Sectoral Exclusion: MSMEs in remote or rural areas face additional challenges due to limited access to formal financial institutions. Smaller enterprises, particularly those in informal sectors, often remain outside the reach of traditional banking networks. Startups and new businesses, which typically lack a credit history, encounter even more significant hurdles in securing loans.

Industry-Specific Risks and Standardized Products: Lenders are often wary of the unique risks associated with various industries. Traditional financial products are typically standardized and do not cater to the specific needs of MSMEs. The lengthy loan approval and disbursement processes further exacerbate these issues, causing delays that can critically affect business operations.

Government Interventions for a More Inclusive MSME Sector

The Indian government has prioritized the MSME sector by launching several schemes to strengthen the credit delivery system and facilitate the flow of credit to micro and small enterprises. Through the Credit Guarantee Scheme, businesses can access loans of up to Rs 5 crore without the need for collateral or third-party guarantees. Furthermore, the Udyam Assist Platform, launched on January 11, 2023, aims to bring Informal Micro Enterprises (IMEs) under the formal MSME umbrella, enabling them to benefit from Priority Sector Lending. While these initiatives mark significant progress, much more can be done to ensure comprehensive support and inclusivity for MSMEs across India.

Educating MSMEs on Financial Literacy: To empower MSMEs, the government should focus on educating them about financial literacy, including managing cash flow, understanding optimal loan terms, and improving forecasting and budgeting. Financial literacy is crucial for MSMEs to make informed decisions and optimize their financial health.

Developing Flexible Lending Products: The government should push lending institutions to develop flexible products that cater to the unique needs of each MSME. This includes customized credit limits, pricing, tenure, and loan terms based on the business dynamics. Phasing of loan payouts and timing of EMI payments can be tailored to meet specific requirements of MSMEs.

Adoption of Standardized Frameworks: Promoting the adoption of standardized frameworks like the Account Aggregator (AA) and Open Credit Enablement Network (OCEN) is essential. Ensuring all Financial Institution Providers (FIPs) are 100% live on AA rails will make banking data readily available to all MSMEs.

Leveraging Alternative Data: Other alternative data, such as common financial statements, accounting ledger data, cash flow information, income tax returns, telco spend, and utility spend, should be standardized and accessible via APIs. This approach would replace the need to manually upload cumbersome documents, reducing the risk of document tampering and fraud.

Streamlining the KYC Process: The KYC process should include both the owners and the business, with virtual and frictionless KYC enabled to simplify the procedure. This would facilitate easier access to financial services for MSMEs.

Developing MSME Scorecards: The government should allow analytics companies to develop MSME scorecards based on a combination of alternate data sources. Currently, only bureau scoring is mature. Partnering analytics companies with interested NBFCs and banks to run pilots can enhance the credit assessment process for MSMEs.

Enhancing Risk Assessment and Pricing: Government can promote AI that can refine the risk assessment process by analyzing a broader range of data and employing advanced algorithms. This can lead to more accurate risk-based pricing, resulting in fairer interest rates for MSMEs. By reducing the cost of borrowing, these enterprises can access more affordable loans, which is crucial for their growth and sustainability.

Promoting Transparency and Reducing Bias: To ensure fairness in the credit decisioning process, the government should advocate for the use of transparent and interpretable algorithms. This approach enhances the understanding of decision-making processes and builds trust among MSMEs. Additionally, comprehensive measures should be implemented to eradicate biases in credit assessment, promoting a level playing field for all enterprises.

Regulating Data Usage for Privacy and Security: While alternative data sources such as SMS can be valuable for credit decisions, they also pose risks of misuse. The government should establish a robust regulatory framework to protect privacy and prevent the misuse of such data in lending practices. Ensuring data security and privacy will foster a more trustworthy and secure financial environment for MSMEs.

Joydip Gupta is the Head of APAC at Scienaptic AI. Views expressed are personal. Reproducing this content without permission is prohibited.