Last year, a report by the Association of Chartered Certified Accountants found that nearly 50.7 million businesses (80% of the 63.4 million MSMEs) in India lacked access to formal sources of credit. According to an IFC report, the MSME sector’s overall credit demand is USD 1.1 trillion, of which only 16%, or USD 168 billion, is financed from formal sources. The rest is financed informally, often through family, friends and local lenders. The reasons for this are multiple. Since 99.9% of these MSMEs are unregistered micro and small enterprises, they are unlikely to have any existing links to state or corporate support. Plagued by a lack of standardized infrastructure and operations, they suffer from huge information asymmetries leading to poor credit adoption. Most of these micro and small businesses remain “credit newbies” or early-stage borrowers with no credit history or ratings. This huge credit gap in the critical MSME sector could disrupt India’s economic growth if left unaddressed.
The need for new lines of credit
Credit growth has accelerated significantly on a large scale over the past two years. However, the flow of commercial credit has remained stagnant in India for more than a decade, fearing a structural credit crunch in desirable market segments. While banks have traditionally been the biggest lenders, they have become increasingly risk averse. The market share ratio of NBFCs to banks has fallen from 0.32 to 0.85 over the past few years.3 Growth in credit availability is a key criterion if India is to achieve its goal of becoming a $5 trillion economy by 2025. At this critical stage in India’s growth, NBFCs must be further enhanced and integrated with fintechs so that much-needed credit deserving segments are galvanized.
Digital financial solutions have the potential to support underserved customers embedded deep within India’s geography and economy. The reach of leading lending institutions, such as banks, often stops short of the local level. Supply chain partners who serve rural India, such as small shops and traders, fall outside the purview of formal credit providers. It is essential to associate them with sustainable lines of credit to ensure their growing contribution to the economy.
Invoice financing can fill in the gaps
This is where technology-enabled invoice financing can make a huge difference. Invoice financing allows small traders to borrow short-term working capital against unpaid invoices. Easing pressure on cash flow helps them maintain and grow their business. On-bill financing is often priced at lower rates than term loans and borrowing limits are more dynamic and meet seasonal needs. Being cash flow-based, creditworthiness is assessed using transaction data, making it more suitable for micro and small businesses that may be new or in an early stage of credit or whose financial situation may otherwise be difficult to determine.
Fintechs, which have been more nimble than incumbent banks and NBFIs, are leveraging technology to seamlessly integrate entity accounting systems on both sides, buyer and supplier. This provides real-time visibility into source transactions, monitors payment cycles and provides accurate invoice verification, improving transparency and trust between creditors, debtors and intermediaries.
Invoice financing models: integrated financing is here to stay
While technology-enabled invoice financing can be offered in a variety of models, the most popular and beneficial models for the MSME sector are on-demand business transaction-enabled invoice financing and anchor financing. Platform-based, transaction-driven invoice financing has already made inroads in the retail industry and seen significant success. Today, built-in “pay later” options for micro and small businesses are gaining traction. These are purchase financing products for small businesses transacting with suppliers, distributors, aggregation platforms or B2B marketplaces. Companies have started integrating on-demand invoice financing into their B2B platforms for small businesses. These integrated financing options integrated into the transaction process provide a seamless and hassle-free experience for businesses and are seeing massive adoption. They allow small businesses to meet their immediate needs without feeling severe financial strain, with more time on their hands to make payments. This is a welcome change in the B2B retail segment, as it provides both convenience and financial flexibility, resulting in faster growth for smaller retailers and better inventory turnover for sellers.
Anchor Invoice Financing is particularly suited to the Indian MSME ecosystem as it offers even the smallest buyers linked to a chain of anchor suppliers, credit for their regular purchases, through a third-party lender . For lenders, the criticality of small buyers’ dependence on the anchor provider for their business reduces the risk of default or non-payment and allows them to provide credit at competitive rates with lead times. flexible payment. The model thus helps Tier 3 and Tier 4 buyers (retailers and distributors) to finance their purchases from their anchor suppliers while making value chains accessible to lenders. This creates a win-win situation for everyone. The anchor provider receives full payment from the lenders, while the buyer gets quick and easy access to required inventory on time, as well as collateral-free credit. The buyer also has the option of establishing a credit report with the lender.
Businesses also prefer these technology-based credit solutions, such as invoice financing, because of the savings opportunities. This allows them to skip lengthy manual approval processes and receive invoice verifications instantly. They can even outsource their accounting, reconciliation, and invoice visibility work to digital interfaces. Additionally, with efficient systems that make funding instantaneous, they are able to access capital more consistently, opening up opportunities for growth and expansion.
Fast, inclusive and accessible: the finance of the future
In many ways, technology is making lending and borrowing simple and more accessible. Now even small merchants who often only cater to a few hundred customers can access funding with just one click. Remote access to capital can help Indian MSMEs overcome the challenge of being at the ends of supply chains, often remote and physically distant from formal lending institutions. This helps them weave themselves into formal financial networks, promoting financial inclusion and growth.
The opinions expressed above are those of the author.
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