The current government’s push for the make in India initiative has brought the SMEs at the forefront once again. As per industry reports, this sector is expected to grow at a rate of 12-15% on an average every year. To boost this growth, in 2017, the Ministry of Small and Medium Enterprises, MUDRA banks, and SIDBI offered support through policy changes in lending and financing to the SME sector. The RBI’s inclusion of the SMEs under priority segment has also ushered in positive changes. Yet, the sector still finds itself in short supply of easy finances. Over 92% of the SMEs get no funding from institutional sources. And that is because lending to SMEs is still viewed as risky.
For most lending institutions, even those specifically looking to tap this segment, the major hurdle is being able to accurately assess the SME’s ability and willingness to pay. As a result, most SMEs find it difficult to arrange business financing from banks and financial institutions and are compelled to resort to informal sources of financing like money lenders. This not only involves prohibitively high costs but more often than not are sporadic, thereby forcing these businesses to operate at much below their potential.
Looking from a technologist’s point of view, there should exist an SME lending process that revolves around small credit assessment and that is also cost effective as well as flexible enough to service the diverse business models of SME.
Non-traditional Ways of Assessing Risk
SMEs do not have traditional collaterals like heavy machinery or factories, large books, long serving marquee clients, etc. to provide comfort to lending institutions. But, the fact that SMEs contribute close to 20% of GDP is good enough to demonstrate that this sector works. The need of the hour is for lending institutions to look at the problem statement differently. Rather than looking at non-availability of collaterals, they need to look at alternate methods of credit assessment that should be based on accurately looking at data points that are available in a systematic and scientific manner. There are non-traditional data points available in form of sales registers, buyers, suppliers, temporary and permanent staff, seasonality of businesses, and local environment parameters like geography of operation, raw-material procurement places, local demand, etc. Using technology, these data points can be collated, summarised and interpreted to come up with models of intelligent credit assessment of an SME business.
Diversity of Business Models
SMEs have different business models depending upon the industry they are operating in. They will have different mode of operations, have different appetites of risks and follow varied payment cycles and so on. Even within an industry, no two SMEs will have the same business model. Their markets will be varied. The challenge then is to have a credit assessment process that will be able to cater to this diversity, without compromising on speed or accuracy.
Technology must be leveraged to create solutions to address this. One of the solutions could be to start with industry-specific credit assessment templates and have the ability to build in further parameters to thoroughly assess risks. These could be about geography, target markets, and source of funds/working capital. And then it could get into specifics of a business to benchmark it against the best, average and worst performers in the industry. Such parameters could include payment cycles and average delays in payment, number of workers, procurement rates, and specific ongoing challenges that the business faces. With many such factors addressed and analyzed, the income assessment for a SME would likely be decently accurate indicator of repaying capability.
Flexible Financial Product Structure
Since no two SMEs will have the same business model, lending institutions cannot market the same financial product to all SMEs. The product offered has to be customized on the basis of an SME’s unique sales and cash flow cycles. And this requires a high degree of skill and experience on the part of the lending institution.
Should the loan payment be monthly, quarterly, half-yearly? If a business is seasonal, then can bigger payments happen when the business is pumped with cash, and smaller ones when it isn’t? Can payments be aligned to cash flow forecasts and revised every quarter, while ensuring base costs for the lending institution are covered? Can some loans have room for planned/unplanned moratoriums in between payment cycles without penalty?
All this clearly mean that it may not be enough to simply tweak an existing loan product to suit the requirement of an SME that has volatile cash flows or seasonal bumper earnings. A technology solution should allow flexibility in designing custom product variants suited for individual SME customer needs without making the entire loans workflow cumbersome or complex, and without compromising on turnaround time, & customer service.
Cost of Transaction
Assessing the credit worthiness of MSME customer can be a cost and time intensive affair. A typical cycle of assessment involves filling and collection of sheets of documents through multiple interactions with the customer and a high degree of collaboration and iterations between sales and credit officer. A large factor of the cost is attributed to the time taken to process a loan which in turn is a factor of manual processes, multiple iterations between sales force and credit teams and involves a large amount of documentation. The advances in mobile technology can help solve the problem of automation of field processes and ability to analyse a lot of information in a more meaningful, and faster manner. Also an intelligent platform can consume niche services in the areas as diverse as bank statement analysis, credit scores basis non-traditional parameters to create a robust and efficient ecosystem to manage SME lending business in a more time and cost-effective manner
A lot of risk in SME lending accrues from a change in the macro-economic and environmental factors governing a business that may play out unfavourably, rather than an SME’s lack of willingness to pay. A profitable lending venture at the time of funding, may run into losses due to changes in the business environment. Continuous Risk assessment is as critical in MSME lending business as is initial credit assessment and hence it’s important for a lending institution to keep a close watch on macro and micro factors affecting its customers. Here technology can be used effectively to put a process for relevant data collection, analysis and controls to monitor early indicators of stress. This, combined with a close dialog with customers can go a long way in maintaining a healthy asset quality by lenders.
With the rising share of SMEs in the economy aided by a favourable government push, the ability to develop financial products suited to their unique needs will be the key trend in the BFSI sector over the next few years. The fintech sector will be looking to create platforms and softwares that will simplify lending to SMEs and significantly reduce the amount of perceived risk.