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Micro, Small, and Medium Enterprises (MSMEs) lie at the center of development in the Indian economy, contributing one-third of India’s GDP and employing nearly 111 million people across all industries. However, the business growth journey for these MSMEs remains challenging!
Funding has perhaps been the biggest roadblock for their growth. Currently, formal credit supply addresses only ~INR 25 trillion worth of MSME financing needs, leaving an addressable credit gap of approximately ~INR 45 trillion. This highlights the substantial financial challenges faced by these MSMEs. To optimize the lending framework and ensure timely access to finance, leveraging financial behavior data may be key to unlocking growth and bridging the funding gap that they face.
What Are Some Challenges MSMEs encounter?
MSMEs often find it difficult to secure loans and investments because of constraints such as inadequate financial documentation, limited credit history, or insufficient collateral. With limited financial aid, most MSMEs are unable to access technological resources struggling to keep up with an evolving market.
Innovation and adaptability are keys to survival and growth, but several MSMEs are struggling to invest in technology, research and development; and penetrate newer markets.
Drawbacks to Traditional Lending For MSMEs
In addition to the challenges in accessing financial support, traditional lenders have a limited understanding of MSMEs’ risk profiles resulting in stringent risk assessment approaches. Further, most traditional lending institutions have lengthy and tedious loan approval processes. This can come in the way of the growth of MSMEs seeking quick access to funds so they can seize market opportunities. Also, traditional lenders typically prioritize tangible assets as collateral. However, many MSMEs, may not have significant physical assets. This can limit their ability to secure loans through traditional channels.
Is Financial Behaviour Data the Solution?
Before we delve into how financial behavior data can unlock growth potential for MSMEs, let’s first understand what it entails. Financial behavior data offers insights into a borrower’s financial activities, including liquidity, volatility, stability, transactions, financial health, creditworthiness, and overall financial habits. With the rise of digital transactions and technology, these data sources are becoming increasingly vital in understanding financial behavior.
For instance, data from digital transactions can reveal cash flow, business volumes, purchase and sale histories, electronic fund transfers, and detailed records of all financial activities such as existing debts, credit card balances, and outstanding loans. These are crucial pieces of information for lending institutions. So, how can this data assist MSMEs? Unlike traditional financial statements, which provide a historical snapshot, digital transactions offer real-time visibility. This immediacy allows for a more dynamic and up-to-date assessment of an MSME’s financial health. Further, digital transactions are more likely to offer a detailed record of cash inflows and outflows, which can then show a more accurate analysis of the MSMEs cash flow patterns. This is crucial for understanding how effectively MSMEs manage their working capital and whether they are facing liquidity challenges.
Finally, alternative data sources can contribute to a more nuanced risk assessment. By examining transaction histories and payment behaviour, lenders and investors can gauge the creditworthiness and reliability of MSMEs more accurately than relying solely on traditional credit scores or financial statements.
Unlocking Growth Potential for MSMEs through Financial Behavior Data
India’s innovative digital public infrastructure has been a catalyst for the growth of the financial services industry. The India Stack, Aadhaar authentication, GST, and Account Aggregator simplify access to financial services. By combining Digital Public Infrastructure with AI/ML and analytics, lenders can continue to enhance their customer selection and risk management processes. Therefore simplifying lending across the value chain for MSMEs.
Moreover, a robust digital stack empowers lenders to enhance credit profiling accuracy, lower borrowing costs, minimize credit risk and ensure higher operational flexibility. This gamut of digital financial infrastructure facilitates seamless access to credit, reduces paperwork, and improves turnaround time, allowing MSMEs to obtain funds quickly and conveniently.
Leveraging alternative data sources allows these entities to develop innovative lending solutions that extend beyond traditional credit scoring, thereby increasing finance accessibility for MSMEs. Combining traditional and digital financial data insights provides a holistic assessment of MSMEs’ financial health, enabling better risk management and decision-making.
