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The recent government campaign celebrating a decade of the MUDRA Yojana underscores the progress made in extending credit to micro-enterprises. The ad claims that by the time your food delivery order reaches home, 3,000 Mudra loans are disbursed. Guarantee schemes have shown promise and progress in bringing the small entrepreneurs and MSMEs of India’s diverse economy under the ambit of formal financing. But India’s MSME sector is large! The sector is expected to contribute 40% of the nation’s GDP in the next 5 years; and contribute heavily to the workforce addition in the next 5 to 7 years. More than 60% of these MSMEs do not have access to formal credit – the unmet credit need is more than $1 trillion.
Lenders need to reimagine their MSME playbook – learnings from retail-lending cannot be replicated as-is. Historically, credit bureaus set the stage for exponential growth in retail credit with cross-lender transparency, borrower discipline and promoting better analytics. Retail Bureaus are mature and well-penetrated now; but lending is stagnating. NTC (New-to-credit) share is <10% and loan stacking amongst existing borrowers is visible. On the other hand, MSME bureau is nascent and under-penetrated. NTC lending is ~40% annually.
The first problem area is that traditional MSME underwriting that is dependent on financial statements and backed by collateral will not help proliferate lending at the speed and scale required. Traditional philosophy was based on collateral and reliance on financials for small loans. Cash-flow based underwriting was reserved for high-value loans and reputable corporates. Reliance and insistence on financial statements have proved to be one of the biggest fallacies of MSME lending. Our experience with several financial institutions has proven that financials do not add to the quality of underwriting small ticket MSME loans – in fact, they are prone to show counter intuitive results.
The second problem is that the cost of underwriting an MSME loan is high. Lenders are required to put their best-skilled (and often high cost) resources for a manual, cumbersome and subjective effort. Even post-disbursement, monitoring of these loans is effort intensive. This raises the cost to serve the segment and consequently the selection criteria become extremely stringent.
The third problem is that unlike retail lending, the MSME-lending template is not standardized. With every loan filtered against a template of net income validation, retail lending had become simple, safe and increasingly digitized in the last 5 to 8 years. Increased competition only made this even more commoditized, adding to delivery speed as well as ease of doing business. MSME lending needs to follow a similar evolutionary curve with cash-flow based financing.
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Lastly, a universal KYC documentation is still work in progress for MSMEs. Udyam aims to solve what Aadhaar has done for retail individuals; but State and Local regulations (e.g Shop and Establishment, F&B licenses) for commercial establishments add to complexity.
However, the formalization of MSME footprint across the ecosystem will act as catalyst to accelerate data-driven lending. Here’s why:
– With merchant QR codes and massive adoption of UPI payments, the smallest of businesses, have been able to “thicken” their bank statements. In our experience, transaction activity is the most authentic data and predictive source of credit risk.
– Ever-increasing coverage, adherence and availability of granular data through GST filings have increased the reliability of business activity.
– Geo-spatial analytics and satellite data can provide location-specific indicators like economic stability, property values, residential, commercial and civic infra, healthcare and criminal activity, and local employment trends. This can help create a “beyond bureau” approach to underwriting.
We come back to the premise that lenders need to find a more profitable and sustainable model to accelerate MSME lending with escape velocity. Here’s the good news. Our strong belief is that the traditional wisdom can be flipped on its head.
– Cash-flow based STP lending (straight through processing) is feasible at scale for MSME loans. Bank statements, GST data can help achieve this aspiration.
– Underwriting needs to leverage ecosystem data and footprint of MSMEs more effectively – with building of right analytics and risk models.
– Journeys and risk models need to accommodate heterogeneity of MSMEs – an ensemble approach is required for the permutations of data footprint available.
– Financial statements (and any other qualitative data) that requires a person-in-the-middle (for interpretation, adjustments) defeat the objectives of a viable model.
– India’s mortgageable assets are beset with problems like lack of clear titles, difficulty in charge creation and cost of house ownership. Govt. Guarantee schemes have done well to bridge and substitute the collateral gap.
Lenders that have reimagined their MSME playbook have produced far superior outcomes. The difference between the best quartile lenders and bottom quartile lenders, across Private and PSU banks is 4X. The size of prize is large – will lenders go back to the drawing board, or will it be more of the same old approach?
Rahul Jain is Head of BCG in India, and Hardik Shah is MD & Partner at BCG.
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