A laborer works on a loom making bed sheets in a textile factory in Faisalabad, Pakistan. (Photographer: Asad Zaidi/Bloomberg)

Digital Lending To Small Business Set To Surge, Says BCG-Omidyar Report

If payments were the chosen flavour of the fintech universe a few years ago, then digital lending, particularly to small business, is the newest opportunity attracting young entrepreneurs.

As the number of digital lending platforms rise and the availability of data around small businesses improves, digital lending to the country’s micro small and medium enterprises could surge, said a report co-authored by consulting firm BCG and philanthropic investor Omidyar Network.

MSME digital lending has the potential to increase between 10 and 15-fold to reach Rs 6-7 lakh crore in annual disbursements by 2023, the report said.

The Gap

The gap in availability of formal finance has plagued India’s small businesses for decades. Despite attempts to increase the flow of bank credit to this segment, a large part of funding is still coming from informal source.

The report estimates the need for SME credit at Rs 45 lakh crore. Of this, Rs 15 lakh crore is met via formal lending to these entities and another Rs 10 lakh crore comes in the form of borrowing by proprietors of these companies. The remaining Rs 20 lakh crore is still sourced from the informal sector, said the report.

Fintech firms could start to make a dent in this unmet need for funding at a time when a larger number of these firms are entering the formal sector, the report claimed.

Across India, the MSME lending landscape is now shifting, with formalization and digitization driving the market toward disruption. Based on our research, we believe that MSME digital lending has the potential to grow 10 to 15 times larger by 2023, to Rs 6-7 lakh crore —nearly as large as the entire global microfinance industry today.   
Credit Disrupted - Digital MSME Lending In India (BCG, Omidyar Report)

A key change which will enable formal lending to these enterprises is the shift of MSMEs from the informal to formal sector. This shift, according to the report, is driven by the Goods and Services Tax and the availability of digital payment options.

A survey of 1500 MSME owners found that 47 percent of these firms have adopted digital tools for business processes, payments and online sales. Thus, in turn, improves the ability of lenders to asses the credit-worthiness of MSME borrowers.

“Roughly 9.2 million MSMEs in India are now GST registered—a more than 50 percent increase from the previous tax regime. The shift to online tax reporting through GST has created a trove of digital data from MSMEs that is verified (invoices matched), granular (invoice level details available), current (monthly/quarterly filing), and electronically accessible,” the report said.

Fintech Vs Traditional Lenders

While this change will enable traditional lenders and new-age financial technology firms to lend more to MSMEs, the report argued that the latter are better positioned to make capture the opportunity.

One key advantage for digital lenders is the speed of loan approvals. Loan approvals on a digital platform can come within a day while traditional lenders may take weeks to sign-off on a loan application. Digital loans have significantly shorter turnaround times than traditional lenders—especially for small-ticket loans, the report said.

Another advantage could be the ability to experiment with newer means of credit assessment. New sources, such as transaction data (e.g., point-of-sale credit card trails) and other surrogate data (eg., telco, utility payments) are giving lenders an even deeper view, the report added.

Should fintech firms manage to make deeper inroads into the SME lending segment, newer borrowers would benefit. Data analysed as part of the report showed that the proportion of new-to-credit borrowers is three times higher for fintech firms compared to private banks, NBFCs, and public sector banks.

As it grows, digital lending could make the benefits of formalization and digitization more visible, particularly for new-to-credit companies. Digital lending could trigger a virtuous cycle by incentivising more MSMEs to formalise in order to reduce the cost of borrowing.
Credit Disrupted - Digital MSME Lending In India (BCG, Omidyar Report)